Wright Cove Capital: October 2022
October 28, 2022
“The waiting is the hardest part,” wrote Tom Petty, famously back in 1981. Forty years later these lyrics aptly describe the current state of financial markets.
Put simply, the Federal Reserve is on a mission to raise interest rates high enough to cool demand, which, according to economic theory will result in increased supply, which ultimately should bring prices down.
Unfortunately for the Fed and for financial markets, there is a lag between how long it takes to slow demand by raising interest rates and implementing restrictive policies. While there are signs that some areas of the economy are cooling (real estate and commodity prices), other areas of the economy (retail sales, labor, and corporate earnings) continue to remain steady.
Hence, we enter the waiting phase, where markets wrestle with not only how high interest rates need to rise, but how much pain must be inflicted before demand falls and inflation fears begin to subside.
Dr. Seuss called “The Waiting Place” a “most useless place,” and we agree.
Rather than being paralyzed by market volatility or waiting and hoping for the best, we continue to look for opportunities that provide both ballast in a down market and participation to rallies – such as what we have witnessed this past month.
We began the year cutting back on both duration and credit-risk across fixed income, now that short term interest rates have risen from near 0% to over 4%, we continue to rotate back into areas of fixed income that offer the most attractive risk-adjusted returns in years. With 1yr Treasuries above 4.5% and 2-3yr Investment grade corporate bonds in the 5-6% range – our rotation out of cash and into the front-end of the bond market seeks to provide both current income and optionality ahead of impending moves by the Federal Reserve.
In equities, we remain focused on companies and sectors with strong balance sheets and business models that can withstand economic downturns. Despite being cautious on risk assets, as we feel Fed policy will continue to be restrictive into 2023, we have slowly been adding to positions in healthcare, energy, and value-oriented sectors. While most of the attention was on the wild swings in tech stocks the past few weeks, there are areas of the stock market that now present encouraging risk-adjusted returns at current valuations.
Heading into the final two months of the year, market strategists and participants are divided on many important issues:
- Have we reached peak inflation?
- Is the Fed going to pause, pivot, or continue to raise interest rates well into 2023?
- Is the recent strength of the stock market the beginning of a new bull market, or just a bear market relief rally?
- Will the War in Ukraine be resolved soon, or will there be further escalation?
- Will there be another wave of Covid lockdowns this winter?
Our challenge is to balance the policies and rhetoric of restrictive monetary policy with the realities of global market and events. What has worked in the past may not work in the future. Instead of waiting for things to normalize, we are looking ahead to 2023 with care and great tact to best position clients for success no matter which way events unfold.
As always, if you have any questions or concerns – or would like to hear more about Wright Cove Capital, please fee to reach out.
Eric and Cass
Eric Leinwand, Principal – Eric@wrightcovecapital.com
Cass Tokarski, Principal – Cass@wrightcovecapital.com
The themes and strategies that we speak about and the positioning we take in portfolios are all customizable to best reflect each of our clients’ own unique goals and should not be interpreted as general investment advice.