While the war in Ukraine has certainly introduced additional volatility to the markets, we do believe that they are short-term risks. The war in Ukraine has been devastating for the people of Ukraine and Russia and we hope and pray for a quick and reasonable resolution. While nobody knows how long the war will persist, the following views are being provided with the expectation that the markets have mostly discounted those risks into prices already. With that being said, what are the risks to the capital markets, specifically for stocks and bonds?
We continue to believe that the main risk over the next several years to both stocks and bonds is inflation. As mentioned earlier in this commentary, we’ve begun to see inflation spread beyond some pandemic-related items to areas where prices tend to be sticky. Economists were expecting to see a relief in prices as the supply of goods improved back to their pre-COVID environment. Unfortunately, this will be delayed due to renewed COVID lockdowns in China, and disruptions in supply from both Russia and Ukraine.
Consensus forecasts in the US sees inflation coming down over the next year, but the risk is that inflation exceeds those forecasts. If that occurs, we believe the US Federal Reserve (Fed) will recognize that it is too far “behind the curve” and will be forced into becoming more aggressive in raising rates due to inflation concerns. An aggressive Fed is never a good environment for stocks and will not be a good environment for bonds either.
What might result in a positive outcome for risk assets? The main trigger would be if economic growth started to show clear signs of weakness. While negative for stocks in the short term, it could cause the Fed to slow down their pace of rate increases, resulting in positive returns for both stocks and bonds overall (bad news/good news scenario). If this occurred in conjunction with a gradual easing in expected inflation over the next quarter or two, this would also be a positive for both stocks and bonds.
While this “bad news is good news” scenario may occur over the next year, we place a higher probability that rising inflationary pressures will force central bankers to be more hawkish with monetary policy over the longer-term and will look to reduce equities further on any type of sustained market recovery. We do believe that while stocks may do OK over the mid-term (12 months), we would look to be more cautious on stocks in the second half of 2023 as the Fed (and other central banks) are confronted with another wave of inflation.
Fortunately for clients of Kinsted, we have more arrows in our quiver than simply publicly traded stocks and bonds. These other asset classes have proven resilient in the first quarter of the new year, just like they were during the Covid crisis of 2020. Having access to assets such as private debt removes interest rate risk from one’s portfolio as private debt tends to use floating interest rates, resulting in better performance in rising rate environments in contrast to bonds which depreciate.
Other private assets such as real estate, agriculture and infrastructure tend to be positively correlated to inflation, so as inflation rises, they should perform well. While private equity and venture capital will be impacted by how the public markets behave, they will likely provide significant upside versus investing strictly in the public equity markets.
As inflation, the Fed, and other variables play out over the next year or two (as there is always uncertainty), you can rest assured that we at Kinsted will ensure that each of our client’s portfolios will be structured in a way to provide the best risk adjusted return. We appreciate every single one of our clients for believing in what we are doing and look forward to working with you and your family for decades to come.
What Happened in Q1?