As our last quarterly commentary mentioned, forecasting the capital markets' future is extremely difficult. To put it into perspective, during December 2021, Consensus Economics forecasted the December 2022 interest rate to be just 0.5%. This month, the Fed raised rates to a range of 4.25% to 4.5%!
JPMorgan, Goldman Sachs, Citigroup (and many Canadian banks) were all bullish last December, expecting the S&P 500 to hit 5100, 5050, and 4900, respectively. The S&P 500 closed the year at 3839, down 19% for the year, which is roughly a 30% difference from what these esteemed institutions estimated a mere 12 months ago.
As we stated before, fortunately, given Kinsted’s lesser dependence on the public equity and bond markets to generate returns in client portfolios, reliance on market forecasts and market cycles is less critical. Many private assets do well regardless of the market environment, and thus the impact of any single asset class is mitigated. This provides our clients with more stable and steady returns over a shorter term of 1-3 years versus having to wait for “the long term.”
In any regard, we believe there’s potentially more downside for global equities for several reasons. First, US monetary policy has become tight due to the very aggressive nature of the US Federal reserve as they try to engineer a “normalized” monetary regime. Secondly, restrictive monetary policy has historically acted as a spark for a recession within a twelve-month period. Also, geopolitically the Ukraine/Russia war does not have an end in sight; plus, China-US-Middle East tensions are increasing.
The markets have priced in higher interest rates which have caused the 2022 bear market. Still, we do not believe they have fully priced in a recession where corporate earnings decline, real estate weakens, government debt and debt servicing deteriorate, and unemployment rises. There is still a chance of a “soft landing” where inflation declines without triggering a recession. However, we believe the probability of this occurring is lower. A recession will not necessarily be good for public equities, even if inflation declines.
One question investors may have: “won’t equities rally if the Fed pivots and starts cutting rates?” Yes, although only temporarily, until the realization that the Fed will not drop back to a zero-interest rate policy, as doing so would unwind all the hardship we have endured this past year. Central banks want to return to a “normal” monetary policy - a neutral rate of 1-2% above inflation and not negative real interest rates. The strategy of “bad news is good news” will no longer play out in a normalized monetary environment.
Please realize that what we have experienced since the government bailed the economy out during the 2008 financial crisis has NOT been normal. Excesses have been built up that need to be unwound, namely - an unmanageable government debt problem. The UK bond market fiasco was a preview of what can quickly happen if “faith” leaves the capital markets. It is going to get harder to fix the economy without relying so much on government support, so expect more hardship for some time to come. We see increasing volatility, and one should not expect to see a resumption of easy monetary policy that has led to stock market rallies over the past 14 (or even 40) years. As we mentioned in a prior commentary, investors should no longer rely on the Fed put!
Therefore, Kinsted has expanded our investment platform to include alternative investments in more stable, diversified, and secure assets like private debt, private equity, private real estate, agriculture, and infrastructure. These types of assets persevere in most types of markets. We are very confident in our outlook over the next 1, 3, 5, and 10 years, where an asset mix that includes these asset classes, with a lower allocation to public equities and bonds, is an optimal strategy for investors.
The key to long-term portfolio success is having a well-rounded asset mix of low-correlated assets that will consistently produce positive returns while maintaining discipline to the strategy. Yes, there are times when one’s equity, bond, real estate, or mortgage exposure will under or out-perform. But to achieve your objectives over the long term, understand that performance dispersion among asset classes should be embraced as part of a long-term, diversified approach.
At Kinsted, we can mitigate these risks as we have more arrows in our quiver than most wealth management firms in Canada.
What Happened in Q4?