21 June 2021
Investing involves the risk that your capital goes down as well as up; you may get back less than you invested. The commentary below is not intended as a recommendation for you to personally buy or sell any of the investments mentioned nor to take any investment action whatsoever.
I wrote in April that the 'burgeoning problem is that the better the economy does, the more likely it is that support for the economy will be pared back.' Well, the economy has been rebounding well and on Wednesday we received the first major signal that support from the US Federal Reserve will indeed be pared back - and that's probably a big deal for markets around the world.
We still don't know exactly when the Fed will take action though the timeline is getting clearer: likely either later this year or early next year. The extent to which its support will be withdrawn remains a big question mark. But, despite not receiving any specifics from the meeting last week, the shift in messaging was unmistakably clear. Only a few months ago the Fed was 'not even thinking about thinking about' paring back its support; now it is actively talking about it.
With this shift in tone we now enter a somewhat more dangerous time for markets. Far, far less money will be given out in 2022 by the Fed than will have been given out in 2021 and 2020. Therefore, there will be less new money available to be used to buy stocks, property, crypto and all the other things that have gone up in price so much over the past 15 months. All else qual, stock prices should, at the very least, not go up as quickly as they have recently and may even decline as the market becomes accustomed to this new reality. As I wrote previously, I envision a significant decline later this year and I believe that's even more likely today then when I wrote it in April (a 'correction' of about 10-20% is my base case).
So what do we do? Sell a bunch of stocks and hunker down? Well, not quite. For one, there are still some reasons to be positive. It is the strong economic recovery from Covid that is allowing central banks like the Fed to now consider paring back their support. While much of this good news is almost certainly already reflected in near-record high stock prices, it is likely that we are in the early stages of multiple years of solid economic growth. That would be good for the stock market. In more technical parlance, while the value of stocks as measured by their price-to-earnings ratio may decline, their earnings may grow at a fast enough rate to ensure that stock prices nevertheless keep going up.
There is also a chance that the Fed will move much more slowly to pare back its support than I currently think or even to reverse last week's decision entirely; this may prove to be particularly true if a new Fed chair (likely Lael Brainard) is appointed in early 2022. A year from now I may be writing about a Fed that is once again looking for ways to hand out even more money - and propelling stock prices higher in the process.
So instead of retreating for the sidelines, we are ensuring that our clients are invested in line with their unique risk appetite so that they are prepared to weather the storm if it does indeed arrive. More specifically, the non-equity parts of our investment portfolios would, I believe, be resilient in the face of a significant stock market selloff (I believe that this is quite different than most of our peers; I am happy to go into this topic in more detail with anyone who is interested).
Whilst I think such a selloff is likely, I also think that it would be a healthy and natural process of long-term wealth protection and creation - though it probably won't feel like it at the time.
With my best wishes for the summer months,
Scott Tindle, CFA is the Founder & Director of Wealth Management at Tindle Wealth Management
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