Markets in search of direction is usually a time when patience is warranted. To be sure, January 2022 was a tough month for risky assets. Risk premium was wiped from technology stocks at a breath taking pace. For one thing, from the rubble new leaders and new risks emerge.
The challenge now is balancing the transition from ultra loose monetary policy to a tightening regime. Unquestionably, this time we are in a different pickle. Looking back at the last tightening cycle there are two big differences. First, is the duration of the tightening cycle. Second, is the inflation level.
The last tightening cycle started January 2016 and lasted until January 2019, a duration of 36 months for a total of 9 hikes. At that time, annual inflation was running at 1.24%. Today the setup is very different, as annual inflation is running at a prickly ~7.12%. To make matters worse, the Fed plans to jam 5-6 hikes in 12 months. Yikes!
Sometimes is helps to list market risk factors to gain better perspective. Unfortunately, this list is ugly and long.
Market Risk Summary:
- Inconsistent Fed monetary guidance, we don’t know if we’re getting 25 of 50 bps hikes. Size and timing is anyone’s guess.
- Raging inflation and a dovish Fed (Wait, wut?).
- Supply chain disruptions, entrenched or resolving?
- Tight labor supply leading to rising wages (aka more inflation).
- Recent spat of terrible economic data (is a recession looming?).
- Approaching the fiscal cliff as stimulus ends.
- Raging energy sector bull market fueling inflation.
Conclusion
In the end, we have an unknown road ahead when it comes to monetary policy. The list of risks facing investors in unprecedented in my view. Indeed, the combination of raising interest rates while the economy slows is a recipe for disaster. Also, is the economy headed for recession, or is Omicron the cause of recent weak economic data? At this point, it’s likely investors will be in “sell the rally mode” until we have a better picture on two fronts: 1) clearer guidance from the Fed and 2) outlook for the economy.
All things considered, now is not the time to ratchet up portfolio risk.
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