Market Outlook? Choppy, sloppy mess at best with high probability of more pain to come…fight inertia and embrace alternatives!

Did you take advantage of the recent nonsensical bear market rally (arguably the most obvious one in market history) to lighten up on equity risk? Did you use the recent decline in bond yields to lighten up on duration? We sure hope so because you had a brief window to get your asset allocation in order. That is the beauty of bear market or countertrend rallies! You get the chance to fix things in your asset allocation. If not, we’re not going to tell you “we told you so,” but c’mon! We can lead a horse to water and all that…FIGHT INERTIA!

1. If you know of someone who needs help escaping inertia, please give us a call and we can help them understand the concept of a “galactic mean reversion” and what steps to take to better navigate your wealth and hard-earned savings through this choppy, sloppy mess.
2. As expected, the recent bear market rally’s eventual demise occurred rather abruptly and violently as the Fed pushed back hard on any irrational fantasies that their current efforts to tame inflation by aggressively tightening monetary policy would magically end in the short term (without a painful recession) and happy days would be here again for markets. Instead, the sledgehammer came out and shattered any hope of a quick Fed pivot.
3. We could bore you with a lengthy discussion of all the fundamental reasons why we are highly confident the current galactic mean reversion between financial assets and the real economy (much like the lost decade and 1964 to 1982) will continue for the foreseeable future, but instead we will just list some of them:

• Elevated recession risk: Significantly higher probability of recession driving weakness in the labor market, lower consumption and lower earnings.
• Still elevated inflation: I believe inflation is still the #1 economic and political problem in the U.S. and on Planet Earth.
• Interest Rates: The end of the 40-year long relentless decline of interest rates that drove lower and lower borrowing costs and justified higher and higher financial asset valuations.
• Globalization moving to deglobalization: This light speed transition to a deglobalized economy in turn will reduce corporate profitability, and corporate profit margins have nowhere to go but down.
• Still elevated equity valuations: Despite the significant declines this year, the 1-year forward P/E ratio for the S&P 500 still sits close to 17x, above the average of 15.1x during the 2010s and in the 65th percentile over the past three decades.
• The peace dividend of the 1990s rapidly turning into a peace tax: Overall there is a rapidly deteriorating geopolitical landscape and even Europe of all places has committed to reaching to help constrain potential future Russian aggression.
• Ex-U.S. global growth in decline: China’s growth outlook is dramatically slower; Europe looks headed for a recession; emerging markets are in bad place.

4. These issues are challenging and important, but it’s not even that complicated. All you need to know is the following:

• Question 1: Does the Fed want tighter financial conditions (higher interest rates, lower equity valuations, wider credit spreads)? You betcha…don’t fight the Fed…high five the Fed. It pains me deeply to see so many investors choose to fight the Fed against all odds.
• Question 2: Does the Fed always get what they want? Without a doubt…maybe not instantaneously, but eventually with almost certainty.
• Question 3: Is that good or bad for markets? We believe bad, very bad…maybe even tragic.
• Question 4: Have we ever gone through Fed tightening cycles before? Yes.
• Question 5: Do they ever end well? Typically, no. I believe there is inevitably some degree of market and economic trauma.

5. The next time you are hearing some inane permabull market thesis, remember those five takeaways.
6. The Fed and the other fundamental reasons in tandem should continue to drive investors to embrace alternative strategies with one or more of the following attributes:

• Downside protection to both the economy and financial markets: This is always important, but clearly more important in these treacherous times.
• Competitive above market income and total return: Anything at or above mid-single digits could be the star of the show for the foreseeable future.
• Low beta/low duration: Less sensitivity to equity and fixed income market outcomes is crucial as the Fed aggressively moves to crush inflation.
• Primarily floating rate exposures that are economically resilient: Don’t fight the Fed, high five the Fed! Continued tightening results in the potential for higher income over time.
• The democratization of alternatives: It is easier than ever to access user friendly alternatives with features like 1099 reporting, daily liquidity and daily pricing.

In closing, we continue to have more confidence in the real economy than financial markets. We are encouraged the labor market remains extremely tight in a weakening economic environment. There is still a nonzero probability that financial markets continue to struggle, but unemployment does not rise materially (although inflation continues to erode wages). The challenge is that recession risk has increased and now the Fed needs a sledgehammer to break inflation instead of a rubber mallet, which further increases recession risk. We have made it through far more difficult times in our nation’s history than the current galactic mean reversion (the global financial crisis and pandemic for instance) and we’ll get through this sloppy, choppy mess eventually. In the meanwhile, the time for alts is now!