What a difference a month makes! As we reach the end of January, the cautionary signal for markets burns a radiant amber. As previously stated, Fed tightening cycles never go smoothly – and so far, not so good. While we’re certainly faced with challenging times, this environment further emphasizes the valuable opportunity in alternative strategies. Let’s consider the landscape:
- The good news: Markets are attempting to reprice both bonds and equities lower (AGG down close to 2% YTD and S&P 500 down close to 10%) in advance of material Fed tightening as valuations for equities compress and fixed income remains a tragic return-free risk asset class.
- The bad news: It appears all the Fed has done so far is slow the pace of their asset purchases. Unless we missed something, the Fed has yet to hike, and their balance sheet continues to expand (albeit at a materially slower rate now versus last year).
- If most of 2020 and 2021 were ranked a 10 out of 10 in terms of how much risk an investor should be taking, 2022 is probably a three out of 10. Fortunately, due to a still robust economy, low expected default rates in credit, and reasonable expected earnings growth, we are not in a “run for the hills” environment like that of 2000, 2002 or the Global Financial Crisis.
- Our base case for 2022 is still akin to 2018. Despite strong economic growth, tighter monetary policy should lead to two to three turns of multiple compression in equity markets, which will be offset by high single-digit to low-teen earnings growth. As a reminder, in 2018 over 90% of investable assets were negative despite strong economic and earnings growth.
- Investors should keep it simple – focus on alternative strategies that have very little sensitivity to interest rates and equity multiple compression. Better yet, focus even more on strategies that actually benefit from Fed hikes. (Isn’t it nice to have something in your portfolio where you are rooting for the Fed to hike as aggressively as possible?)
- If ever there was a year for cash flow, market-neutral strategies and tactical trading, it’s 2022. In certain years like 2021, capital appreciation is king. In a year like 2022, cash flow is king. Strategies that offer steady, above-market income can serve not only as cash and fixed-income replacements but also equity replacements.
Ultimately, investors should not agonize about a return to a challenging market environment. Fortunately, there are far more seasoned, user-friendly alternative solutions in the marketplace today due to the democratization of the asset class over the last two decades. So rather than fretting amid these challenges, investors can find a more optimistic outlook in alternative strategies.
