FED-WATCHING LIKE A HAWK
Nov 30, 2021
Turning points in central bank policy can be volatile affairs, as investors attempt to gauge the scale and rapidity of the forthcoming changes. Or at least that has historically been the case anyways. The Federal Reserve began providing “forward guidance” in the early 2000s under Alan Greenspan’s leadership; telegraphing changes before their official announcement to help lessen the shock. This approach proliferated under subsequent Fed chairs Ben Bernanke and Janet Yellen, but has arguably been taken to new heights under current chairman Jerome “Jay” Powell.
It is perhaps unsurprising then that Joe Biden reaffirmed Powell’s position at the helm of the Fed last week. With the US economy recovering smartly from a short-lived recession and inflation proving to be “stickier” than most economists initially expected (please see our recently published Special Report: Road Trippin’ for an expanded look at inflation), extreme levels of monetary accommodation are no longer necessary. But try telling that to a crowd of stimulus-addicted investors. This is where Powell shines. His steady, in depth expositions of the committee’s cautious approach takes the form of a Barry White song’s soothing timbre (which is actually helpful for the most uptight of investment nerds such as yours truly). Undoubtedly, many investors were hoping that Lael Brainard would get the nod to replace Powell, given her more dovish leanings (she was named the Fed’s vice chair instead). However, the largely muted financial market reaction would suggest that Powell’s reappointment was widely expected and that the status quo is not particularly worrisome. We tend to agree. Even if Brainard had become chairwoman, QE tapering has already been set in motion (essentially making it irreversible in the near term) and the path of least resistance for interest rates is up. While the timing of the first rate hike is still open to debate (per the chart below, FOMC members are currently evenly split on whether the policy rate should be raised next year), the committee members’ projections are all consistent in direction over the next few years with relatively low dispersion.
With an FOMC meeting scheduled in mid-December, it is easy to fall down the rabbit hole of dissecting every minor detail. What verbiage has been added and removed from the previous minutes? What was Powell’s tone? What colour tie was he wearing? I digress. Keeping a big picture perspective is imperative. What are the most critical points currently on our radar?
We expect “behind the curve” central banking to continue, as the Fed (as well as the European Central Bank and Bank of Japan) errs on the side of caution in their response to above-target inflation. The “average inflation targeting” measures implemented last year formalized this approach, providing justification for the Fed to let inflation run hot. From a short-term perspective, this is a favourable backdrop for economic growth, as modestly tighter monetary conditions should not derail the recovery. Crucially, monetary policy is no longer doing all of the heavy lifting. Fiscal stimulus (which was dormant during most of the post-2008 recovery) has been engaged in major economies around the world; providing a powerful multiplier effect to the global economy. We expect that risk assets such as equities will continue to perform well in this environment, and have increased our equity overweight in client portfolios.
GLOBAL STRATEGY OVERVIEW
In previous quarters we had raised cash above benchmark to protect against volatility as soaring market expectations had caught up to (and subsequently surpassed) underlying economic fundamentals, creating downside risk. With investor optimism levels fading substantially over the past quarter, we are much more comfortable increasing exposure to risk assets. We have deployed cash in client portfolios this quarter; bringing cash (and equivalents) levels back in line with benchmark.
The pervasiveness of negative real fixed income yields has made our income generation objective all the more critical. In addition to maintaining existing high-yielding exposures such as emerging markets debt, senior leveraged loans and mortgage REITs, US residential REITs stand to benefit from a peaking work-from-home trend and an over-extended price-to-rent ratio (at a decade high). US residential REIT exposure has been added to income-oriented strategies this quarter.
Equities remain the preeminent asset class exposure to align with our base case scenario of a multi-year economic expansion. As investors scaled back expectations markedly last quarter, there is now potential for corporate earnings to surprise on the upside and stock prices to follow. We have increased the overweight equity positioning in client portfolios this quarter.
Forstrong previously exited exposure to Chinese internet equities as lofty valuations and an increasingly hostile regulatory environment clouded the outlook. What followed has been a stunning collapse in share prices, as Chinese policymakers went on an all-out offensive to rein in and regulate the rapidly growing sector. Now, with more clarity regarding the policy framework and much more reasonable valuation multiples, Chinese internet equity exposure has been repurchased in growth-oriented strategies.
Gross-of-fees performance ($CAD) as of October 31, 2021. Returns for periods greater than 1 year are annualized.