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  • William Combs

Letter to Investors: The Wait of the World

As the months in 2022 continue to pass by, we wonder if the Fed, inflation, or the economy will give in first.


Dear colleagues, clients and friends,


If you’ve been following our quarterly letters and attending calibration discussions, you’ve heard us talk about the Federal Reserve and inflation. And while we anticipated that the Feds action to raise interest rates would cause a decline in asset values, we also hold the position that a decline in asset values and a weakening economy does not translate to a reduction in inflation directly. While we hope that inflation declines, hope is not a strategy. For the last few months, markets have traded on the expectation that the Fed’s plan to raise interest rates would lead to a win against inflation. If the Fed is successful in it’s bid to tame inflation, then inflation hedges such as precious metals, managed futures and commodities would likely lose value, as we’ve seen in market trading over the last few months. If the Fed is unsuccessful, then we question their ability to continue fighting inflation without larger, more noticeable impacts to the economy that would make it difficult to pursue higher interest rates. These two possibilities have very different outcomes.



Source: Bereau of Labor Statistics


With the October CPI at 7.7%, the lowest since January, we anticipate hearing things like, “peak inflation”. We have our concerns that this is not the case. From our study of inflation, it moves in cycles, with lower ranges allowing for policy missteps that prolong the inflationary period. What we also know to be true, is that markets operate based on available information, and the key to market inefficiencies is determining two factors (1) is inflation slowing down (as reflected in the CPI) or (2) is the Federal Reserve going to stop or slow down rate hikes. If you know these two things, you are ahead of the markets. Unfortunately, these two things are entirely unpredictable. Don’t believe me? Then, a friendly reminder that the Federal Reserve (and many economists and bankers) couldn’t predict that we would be dealing with the current level of inflation.


And this, is the wait of the world. As each month passes by, markets wait to see what the latest CPI number is. And shortly after, they wait to see what the Federal Reserve has to say about it. Will they? Won’t they? It has all the excitement of the latest made-for-tv drama. And it is impactful. It moves markets by the 10’s of percentage points. And for now, it would appear that the markets are anticipating weaker inflation readings and softer inflation-fighting rhetoric from the Fed. If they continue to get those two things, expect for risk assets to perform well. And, should we get a higher inflation number or a more aggressive message from the Fed, expect markets to retract.


This is not a place to remain idle. The place we are at is precarious, in that as plausible as a 20-30% rise in markets is, so too is a 20-30% drop down. It just depends on what the CPI and the Fed say.


For now, take advantage of the rebound in risk-based assets. Reposition to higher conviction, long-term positions. The opportunity also presents what may be a near term peak in interest rates, which would mean that stability can return to the fixed income world.


Our view on inflation:

Inflation is not a cause and an event, but rather it moves through the economy with some impacts negatively reinforcing others. If you look back to our first article this year, we reflected on the 10-year cycle of inflation fighting that was dealt with in the 70’s and 80’s. With much lower interest rates, and much higher amounts of debt, we hesitate to believe that the inflation fight today will be as short and as simple as the Fed suggests. We believe that the current lower inflation readings are to be expected as inventory surplus is cleared. Once that surplus is cleared, we do not believe that reductions in prices will continue. Inflation above 2% is considered excessive, so we anticipate the current inflation will be noticeable in the economy.


Opportunities:

  • Hedging: Options may be inexpensive given the current market sentiment. Given the fundamental downside that exists, consider hedging assets that are important to your long-term success. If you cannot risk the loss of certain assets, consider repositioning them to non-correlated assets, or insuring them using options, structured notes or insurance companies

  • Tax loss harvesting: Now may be a good time to consider using your portfolio to help offset any outside gains you may have (business, real estate, etc.). Utilizing losses in your portfolio can help to significantly offset capital gains. Please consult with you tax advisor.

  • Allocation: Market drawdowns should not be the sole reason for adjusting your allocation. It does however, give you a window into what your portfolio holds and how it responds to severe risks. For some, this may have been a wake-up call to tech exposure. For others, they may have realized that the positive returns don’t help to offset the emotion from significant drawdowns. There are ways to adjust your portfolio so that you can stay invested long term, such as shifting to higher conviction positions.

  • Fixed income: Bonds have caused a lot of concern this year as they have dropped in value from pressure from both interest rates and inflation. The drop in price has caused an increase in yield that some may find attractive as an alternative to stock markets. While we still believe bonds to be a volatile asset class, being able to hold short-term bonds to maturity may be a strategy worth considering, especially for those looking to generate income.


Sincerely,


Bill Combs and The Olivia Team


Registered Representatives and Financial Advisors of Park Avenue Securities LLC (PAS). OSJ: 5280 CARROLL CANYON ROAD, SUITE 300, SAN DIEGO CA, 92121, 619-6846400. Securities products and advisory services offered through PAS, member FINRA, SIPC. Financial Representative of The Guardian Life Insurance Company of America® (Guardian), New York, NY. PAS is a wholly owned subsidiary of Guardian. WestPac Wealth Partners LLC is not an affiliate or subsidiary of PAS or Guardian. Insurance products offered through WestPac Wealth Partners and Insurance Services, LLC, a DBA of WestPac Wealth Partners, LLC. Olivia CA Insurance License Number - 0E57168, Olivia AR Insurance License Number – 2343024 | Combs CA Insurance License Number - 0I49903. | Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. | 2022-147292 Exp. 11/24


Material discussed is meant for general informational purposes only and is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice. Data and rates used were indicative of market conditions as of the date shown. Opinions, estimates, forecasts and statements of financial market trends are based on current market conditions and are subject to change without notice. References to specific securities, asset classes and financial markets are for illustrative

purposes only and do not constitute a solicitation, offer, or recommendation to purchase or sell a security.


Past performance is not a guarantee of future results. All investments contain risk and may lose value. Investing in the bond market is subject to certain risks including market, interest rate, issuer, credit and inflation risk. Equities may decline in value due to both real and perceived general market, economic and industry conditions.

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