Whatever It Takes: Finding your footing in the new normal
After a rocky start to the year when most market averages fell by 20% to 30%, July and early August saw a healthy rebound. Investors convinced themselves that the U.S. Federal Reserve was going to reverse its hawkish course when it next met to set interest rate policy in September and a snapback in risk assets commenced.
However, Chairman Powell’s August speech in Jackson Hole—which was over in less than 10 minutes—was unequivocal in reemphasizing the body’s intent to do “whatever it takes” to get inflation wrestled back in the bottle. Powell invoked memories of then-Chairman Volcker’s historic fight back in the early 1980s, and reiterated earlier testimony that there may well need to be economic pain and a period of hardship in order to achieve price stability—a code phrase for inflation more in line with the Fed’s long-term target of 2%.
Barring unforeseen events of a political nature, we suspect markets will stay range-bound and volatile through year-end, with little to force them strongly up—or down. Investors, corporate leadership, and global citizens alike are struggling to find their footing in the new normal. While human nature yearns for a return to the “before times,” the sooner we all adjust to the fact that we’re writing a new book—not just a new chapter—the sooner we can hone in on what the future may hold. Let’s discuss some of the intermediate to longer-term headwinds and tailwinds currently at play that will influence investing and markets in 2023 and beyond.
Negative indicators include the following:
- Global supply chains are being repositioned. Long before Russia invaded Ukraine and disrupted the energy, grain, and raw materials markets, China’s rolling Covid shutdowns and tariff spats with the U.S. were causing many domestic and European companies to rethink where their products were manufactured or assembled. Exacerbating the issue were backups at U.S. ports, weather-related traumas for shipping (e.g., the Rhine) and ports, and, more recently, China’s show of military force in and around Taiwan. It’s a toxic cocktail of events pushing companies toward local manufacturing and distribution schemes. This may well turn into a long-term tailwind for specific locales as infrastructure is repositioned closer to end markets—but it could also be a drag on margins in the meantime.
- Everyone needs time to anchor to the new normal (higher) cost of capital. It’s tough to remember that we have been in “ZIRP” (zero interest rate policy) for more than a decade—and most global central banks are raising rates back toward historically more “normal” levels. While inflation is running hot around the globe, interest rates in general have climbed back to long-term averages. Indeed, the mortgage rates that produced the 2008 global financial crisis were between 5.5% and 6%. Until companies and citizens have woven these more normalized rates into their analysis, business expansion, home purchases, M&A, and capital expenditure (capex) may remain fitful.
- Margins are likely to be pinched as costs from labor inputs, expanded capex, higher commodities costs, and the like are absorbed. As pent-up demand surged early in post-Covid reopening, companies were able to pass at least some of these on. We suspect that will become more challenging to do moving forward, and are already seeing signs of this. To retain any sort of pricing power, companies will need to be very clear about their unique value propositions.
Positive indicators include the following:
- Schools are back open. Life is beginning to fall into some semblance of a new order. With more kids back in school, more parents are able to commit to reentering the labor force, even if in a more flexible capacity. And businesses are settling into working through their own post-reopening blend of in-person, remote, or hybrid work. As newroutines increasingly become established, companies should have a more reasonable time planning for inventories, sales, staffing, and real estate needs. The clarity gained from an ability to plan more accurately should trickle through to increased investor confidence in corporate guidance.
- Mid-terms have passed. The political season always brings its share of hand-wringing and contention, and the 2022 mid-terms were especially fraught with big, polarizing issues. On the first Wednesday in November, however, it will all be over (at least until the 2024 cycle starts sometime in 2023), and investors can turn to focusing on economics and corporate profits.
- Substantial fiscal stimulus from 2021 and 2022 spending packages is headed into the system. Turning on the fiscal stimulus even as the Fed is withdrawing monetary stimulus has not been done in the past few cycles, and should lend support to economic activity. In fact, opportunities in infrastructure, energy, health care, education, and a host of other industries could well pique investor interest as 2023 commences, giving interesting options for sideline-weary cash holders.
It’s important to remember that in any given year, markets are always faced with challenging headlines and dour prognostications. Parsing through them, however, can often lead to interesting insights and opportunities for those who have the wherewithal to think and act long term.
Carol Schleif is deputy chief investment officer at BMO Family Office, a wealth management advisory firm delivering investment management services, trust, deposit, and loan products and services through BMO Harris Bank. To learn more visit bmofamilyoffice.com.
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