Finding an alternate route in a yellow-light market

Chief Market Strategist Troy Gayeski shares his latest take on the markets.

Troy A. Gayeski
January 13, 2022 | 5 minute read

Happy New Year! The green light for taking risk in markets, despite burning bright since the pandemic market bottom, has now turned to a cautionary yellow. While economic growth remains strong, increasing uncertainty in financial markets reinforces our belief that now is the time to look towards alternatives and other strategies that may benefit from shifting market leadership. Here are a few things to keep top of mind when considering the state of today’s markets.

  1. The Fed is rapidly turning the page from the most exceptionally loose monetary policy in history to tighter policy. Considering both the economic and political impacts, the Fed can clearly no longer ignore the highest levels of economic inflation in the past 30 to 40 years and will likely be tightening policy far faster than they did after the Global Financial Crisis.
  2. The outlook for vanilla fixed income remains exceptionally challenged. Yields remain incredibly low with high levels of duration risk going into a tightening cycle, and now inflation is eroding the principal at an alarming rate.
  3. Equity markets enjoyed impressive performance over the last 21 months due to fundamental revenue and earnings improvement, along with multiple expansion from unprecedented money supply growth. We now believe that the probability of further multiple expansion is slim, and the likelihood of some degree of multiple compression is high. We believe taking an active approach to recognize shifting equity market leadership is going to be key in this environment.
  4. Traditional 60/40 portfolios find themselves stuck between the Fed and elevated valuations/low yields. At least when the dotcom bubble began to collapse in early 2000, there was a 6%+ 10-year treasury yield and meaningful upside potential in fixed income as equity markets collapsed. Last year, when vanilla fixed income was the definition of return-free risk, equities still had significant upside potential. In 2022, the outlook is no better for fixed income and a much more uncertain environment for equity beta.
  5. It’s déjà vu all over again…Initially, many alternative investments were primarily utilized as a replacement for equity risk driven in part by the client experience coming out of the internet bubble collapse. More recently, alternatives have been increasingly used as a replacement for fixed income. For 2022, we believe alternatives are a timely replacement or complement to both fixed income and equities.

As a closing thought, the tone of this message is certainly not ebullient for vanilla asset classes. However, on a far more positive note, we believe the real economy is in exceptional shape and 2022 should be a year of strong growth, which is clearly most important for society. Every now and again we go through periods where the real economy outperforms capital markets, and 2022 is shaping up that way again. From a different perspective, having the Fed tighten policy faster and harder than most market participants expected (three to six months earlier) is a great thing. It is far better to have excesses purged early while the real economy can weather it than to permit bubbles to form that ultimately implode, or to allow real economic inflation to ravage those most vulnerable in society. So while the yellow light is glowing for capital markets, we can cheer on the Fed for keeping markets honest and giving the real economy a chance to catch up.

This information is educational in nature and does not constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment. FS Investments is not adopting, making a recommendation for or endorsing any investment strategy or particular security. All views, opinions and positions expressed herein are that of the author and do not necessarily reflect the views, opinions or positions of FS Investments. All opinions are subject to change without notice, and you should always obtain current information and perform due diligence before participating in any investment. FS Investments does not provide legal or tax advice and the information herein should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact any investment result. FS Investments cannot guarantee that the information herein is accurate, complete, or timely. FS Investments makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information.

Any projections, forecasts and estimates contained herein are based upon certain assumptions that the author considers reasonable. Projections are necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the projections will not materialize or will vary significantly from actual results. The inclusion of projections herein should not be regarded as a representation or guarantee regarding the reliability, accuracy or completeness of the information contained herein, and neither FS Investments nor the author are under any obligation to update or keep current such information.

All investing is subject to risk, including the possible loss of the money you invest.

Troy A. Gayeski, CFA

Chief Market Strategist

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