Market update: As capital markets waver, the real economy thrives

Here we are, halfway through Q1, and the outcomes for equities and bonds have only gotten worse:

1. Big news in the fixed income market: Even to market veterans like ourselves, it is still amazing to see that in less than 6 weeks, the Barclay’s Agg has given up over a year’s worth of income and has performed worse than the entire calendar year of 1994, which is still legendary for bond market carnage.
2. Now to equities: Despite the valiant efforts of dip buyers, the S&P 500 has continued its downward trajectory driven by escalating inflation and more aggressive potential Fed tightening, combined with the threat of a Russian invasion of Ukraine.  
3. What does this mean for the 60/40? The hangover from the dramatic outperformance of risk assets and 60/40 equity/bond allocations compared to the real economy in ’20 and ’21 driven by massive monetary and fiscal stimulus is approaching the migraine stage. The combination of fiscal and monetary policy largesse has now culminated in the highest inflation levels of the past 40 years, which in turn is forcing the Fed’s hand to remove the punchbowl far more rapidly than market expectations as recently as 6 weeks ago. The resulting market turmoil was as predictable as the sun rising in the East.
4. Now the good news: The good news is that just like the Fed’s largesse impacted asset valuations far more dramatically than the real economy in 2020 and 2021, the tightening of Fed policy should continue to weigh far more on capital markets than on the real economy.
5. The real economy performs: The real economy continues to perform exceptionally well, given the recent omicron-driven COVID surge as demonstrated by impressive employment growth in January that was far above expectations. Additionally, it appears that the worst of the omicron surge is now behind us and the pandemic is inching toward becoming endemic.
6. Our base case: Our base case continues to be 2–4% real economic growth and 5–8% nominal GDP growth (adjusted for inflation) with upside surprise to the nominal number in particular given continued elevated inflation. Growth should be driven not only by consumption, but also business fixed investment and an inventory rebuild.

In an environment where the economy should do fine but capital markets struggle, we believe there has been no better time to consider alternatives. The time for alternatives is now.