BCA Weekly Commentary 10/21/22: Raise It Till You Break It
ECONOMIC IMPACT. This week, contra to all near term signs of abating inflation and slowing growth (both not yet reflected in official govt stats), the Fed indicated even more aggressive rate hikes whereby the Fed funds target may rise to 5%. This is largely baked in as the 1yr Treasury note is 4.7% as of this moment. THE FULL EFFECTS OF THIS IS ONLY BEGINNING TO GET REFLECTED IN BROADER ECONOMY especially in light of the extreme pace & magnitude vs historical rate hikes. Antidotal evidence of a significant slow down in economic activity ex the reported govt data includes: Housing sentiment, shipping, ad spending & retail activity as per corporate America earnings reports, used car prices and the like. WE CAN NOT CONTROL THE DECISIONS OF MAD MEN (ie the FED) EVEN DESPITE OUR STRONG BELIEVE IT WILL CAUSE IRREPRABLE DAMAGE TO DEMAND & NOT ADDRESS THE CORE INFLATION SOURCE. And to reiterate, the demand destruction, is in areas ex food & energy where demand is already depressed and getting worse! The Fed is "pushing on an inflation string" and in the end "WILL RAISE IT TILL IT BREAKS IT" meaning it may raise rates whereby not only causing a recession but another financial crisis. To reiterate, we believe post the mid-terms this reality maybe be born in the economic numbers soon enough. Lastly, the inflation born today is mostly tied to the war and until that gets resolved inflation may not return to the FED's target level of 2% for sometime if at all. Thus, why consensus is growing that rates will be stuck elevated causing a sustain period of no growth and elevated inflation ie STAGFLATION. Further, concern is growing on a deeper recession as well in 1H23 which given FED indications of another 75 basis pt hike in November (is not out of question) maybe the base case.
INVESTMENT IMPACT. The key to market stability maybe tied to interest rates stabilizing or falling particularly the 10 year Treasury bond. Once economic data turns down reflecting waning inflation & growth so may long term rates signaling the Fed pause. We may not be too far from that as we said above. With all that in mind we continue to favor high dividend paying stocks that are depressed and may largely reflect recession. Current yields on models are approaching 4.5% on growth side and over 5% on income side ex fees. Our base case is a sustained period of no or little economic growth for sometime to come thus our philosophy that owning stocks must come with an incentive to hold them via a high dividend. When interest rates fall in realization of recession these stock we believe should appreciate while providing a steady stream of income vs growth stocks which may not do well despite fundamentals if rates remain elevated and overall growth remains low.
We remind investors, that being early, does not mean you are right in short term, but positioned well for the long-term. The Fed was wrong about inflation being transitory and it maybe wrong again that its extreme actions will cause a deeper recession in 2023 despite their belief of POSITVE GDP growth next year (which we DO NOT agree with). The pace of corporate earnings adjustments for 2023 as we move thru earnings season to reflect negative earnings growth reinforce that view.
We remind investors that going forward expectations for returns for the overall market over the next decade remain low as we expect well below returns vs history. Be that it may we are hopeful our models can improve on that going forward.
Our model portfolio performance has been updated as of the date of this newsletter.
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