The Fed’s policy communications showed impatience with the present inflation backdrop and a desire to tighten monetary policy more quickly.
US monetary policy uncertainty has been a “tipping point” for the liquidation of US financial assets, first led by fixed income, then the most highly valued speculative growth stocks, and now higher quality assets. Before a sharp intra-day reversal, the US Nasdaq composite slipped 14.0%, the S&P 500 10.0% and the Dow 7.7% in just over three weeks.
Fed policy tightening has generally “followed the economy and markets” up, only serving to catalyze retrenchment after very full business cycle recoveries and unhealthy booms (see figure 1). In the young 2022, it appears many market participants already assumed the “end game” of the Fed’s brush with excessive tightening in 2018 (see figure 2).
With the exception of deliberate steps to induce recessions in 1980 and 1982, Fed tightening hasn’t single-handedly driven US economic cycles. In the current backdrop, we believe the Fed can approach policy tightening gradually to avoid forcing the US economy into a new downturn.
There is a great deal of “fast money” volume generating heightened volatility. We believe very rapid turns in financial market sentiment are due, in part, to “new trader” participation (see figures 3-4). Open call and put volumes were nearly 60% above levels one-year ago.
Individual investor sentiment has now turned decisively bearish in the face of what we expect will be EPS gains for the fourth quarter 2021 exceeding 25% (see figures 5-6). This is usually a contrarian market indicator. However, we believe a recovery in shares will depend on the delivery of further EPS gains in the near-term with views to sustaining them further in 2023.
We believe the sharp moves are increasing the emotional component of the investment/tradingprocess. Technical levels and momentum have taken over from fundamentals – for now. We believe these are times to keep calm, assess if fundamentals have actually changed, and act on data andanalysis, not fear. This is particularly true for long term investment strategies.
While we’ve worked to position portfolios for greater risks last year - including reduced absolute equity weightings and shifts toward higher quality dividend growers - the speed at which markets have jumpedto pessimistic views has surprised us. While we don’t anticipate a more friendly turn in monetary policythat would return speculative investments to boom conditions, we are willing to add to positions in high conviction, long-term growth themes that have fallen sharply in price (see figure 7).
We see higher quality dividend growth shares – firms generating sufficient excess cash that they can raise payouts to investors – as our highest conviction core equity holding. Far from the speculative frenzy, these have outperformed this year (see figure 8-9)
FASTER AND FASTER MARKET
Steven Wieting, Chief Investment Strategist and Chief Economist
Joseph Fiorica, Head, Global Equity Strategy
Jorge Amato, Head Latin America Investment Strategy