By Geoffrey Muns
Investors have eyeballed the Fed for most of 2022, banking (for lack of a better word) for rate hikes aimed at fighting inflation. Signs of cooling inflation nudged investors, pushing SPX up 14% since a low in October. Meanwhile, Treasury rates have fallen notably, reflecting expectations for both lower inflation and lower inflation-adjusted interest rates.
With Fed policy and expectations for lower rates, investors are missing the impending policy tightening of an economic slowdown.
The US economy is likely to begin feeling the effects of this year’s policy tightening in earnest in 2023, since the economic effects of changes in monetary policy tend to lag by between 6 to 12 months. Morgan Stanley expects 2023 GDP growth to be soft, with corporate sales volumes, pricing power and profits likely taking a hit. However current earnings expectations and stock valuations don’t seem to reflect this outlook.
I feel investors should shift their focus from the Fed’s rate hikes to consumer activity. That’s because consumer spending, which makes up two-thirds of US economic activity, will likely determine the timing and depth of the economic slowdown. It’s also likely to influence the timing of actual interest rate cuts, which historically have been a more reliable sign of the end of a bear market.
We need to acknowledge that the US consumer has been extremely strong in 2022:
- Labor market has remained resilient with unemployment rate at 3.7% in Nov, barely above the 50 year low.
- Wage growth although not completely offsetting inflation, has been solid at a between 5-6% annual range.
- Personal spending has held up with Oct data suggesting an annual pace of real consumption of 6%.
- Inflation adjusted retail sales growth has stayed above the trend since 2015.
BUT warning signs of a coming slowdown are flashing red:
- Personal savings rate once boosted by fiscal stimulus relief has plummeted from a peak of 33% in Apr 2020 to 2.3% in Oct 2022, the lowest it’s been since 2005.
- Credit card revolving debt has surged to an all time high, at nearly $1.2 trillion.
- Number of new job listings is down, as reflected in the Job Openings and Labor Turnover Survey. There were 10.3 million vacancies for Oct, the latest monthly data available, down by 760,000 from a year ago.
- The same survey showed a downtrend in the “quits” level, edging toward 4 million, compared with the record 4.5 million in Mar 2022. This suggests people are less confident about their prospects for finding employment elsewhere.
I believe watching the labor market and consumer spending data, as they will help determine what is next for the US economy. What’s important for investors to grasp is that a growing anxiety about a slowing economy does not seem to be factored into current stock valuations and earnings expectations. As bear markets driven by policy don’t typically end until earnings estimates reach a trough and the Fed actually starts cutting rates, this means we are likely to be waiting awhile before this bear market in equities is truly over.
I recommend investors consider harvesting losses for potential tax benefits and focusing on income. It may make sense to re-invest proceeds into yield producing assets, such as treasuries, municipals, corporate credit, MLPs and REITs.
Tactical reasons to consider adding gold to a portfolio.
Given gold’s low correlation with other asset classes, such as stocks and bonds, gold can provide an important role in portfolios ie diversification. Gold’s ability to act as a “store of value” can help mitigate risk during times of market volatility and economic uncertainty. It may be able to serve as a hedge against inflation. In addition, gold historically has exhibited an inverse relationship to the US dollar, meaning as the dollar weakens, gold tends to rise.
Three main ways to get exposure;
1) Physical Gold
Investors can buy gold bars and coins as part of their brokerage account and can also own gold minted coins as part of their retirement account. Investors may pay a premium over the spot price of gold. The gold is physically held by a third party. Storage fees usually apply. Investors can also take delivery of physical gold if they want to store it themselves. In such cases, delivery fees would apply.
2) Gold funds
Some mutual funds and ETFs also offer investors exposure to gold. For funds that offer the most direct exposure, their value tracks the price of gold. The fund shoulders the cost of holding physical supply and passes it along to the investors in the expense ratio.
There are some drawbacks though. Some gold funds are taxed as collectibles, so they don’t benefit from the lower long-term capital-gains rates for which stocks may qualify. Plus, they don’t produce any income, so the expense ratio can eat into principal every year.
3) Mining companies
Investors can get exposure through equity in companies that mine for gold, including the purchase of individual stocks or as part of a fund.
The mining companies tend to be more volatile than physical gold. Typically, the mining sector correlates with the price of gold, but individual stocks may face company-specific risks.
Even within this sector, choosing a fund can be complex. Some funds own companies that mine different types of precious metals, some funds are global and others own only small and mid-cap mining companies. Investors may not know which is appropriate for their risk tolerance and asset allocation plan.
Gold as a Hedge
Investors may feel they should reduce their allocation to equities if the odds of a US recession rise, but as previously mentioned, investing in gold may be an approach to consider. Historically, gold prices tend to rise when bond yields, adjusted for inflation, fall. Conversely, a stronger dollar and rising yields, driven by improved global growth, would likely limit gold’s upside.
While gold isn’t typically viewed as a long-term strategic investment, for some investors, an allocation to gold as a component of a diversified portfolio may be worth considering.
Whether it be gold coins, bars or ETFs, contact your Financial Advisor to find out which vehicles could be best for your portfolio.
Time to exit all markets in exchange for profit taking or rebalancing if you’re not in the money, but some investors may stay in for the santa rally, which I don’t much care for as the risk IMHO is not worth the peace and tranquility for this special month.
Risk warning – As with all investing, your capital is at risk. The value of your portfolio can go down as well as up and you may get back less than you invest. Past performance and the contents of this outlook is not a reliable indicator of future performance. This article/print is protected through international copyright & print laws and may not be reproduced, distributed or copied without exclusive permission from the writer.
Geoffrey Muns is an Independent Financial Advisor and Planner certified from the UK, US and UAE based out of Dubai for the past 20 years. He also works in the PE/VC space and is a seasoned investment banker having worked with international banks and investment firms in the region. You may contact him at firstname.lastname@example.org