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The World Has Changed

Decades of falling interest rates and globalization of manufacturing and labor have in many instances reversed course. This new world order is asserting itself on capital markets, and will likely continue to do so over the longer-term as well. It is important for investors to understand these implications, and to adjust their strategy accordingly.

  • Central banks, led by the Federal Reserve, went on a buying spree to revive economies following several exogenous events over the past few decades. The mother of all events - the global pandemic - required monetary authorities to pull out all the stops. Here in the U.S., the Fed’s balance sheet ballooned in size, and it now owns around half the outstanding issuance of the key 10- and 20-year benchmark Treasury bonds.

  • This artificial compression of rates across the yield curve in recent years was successful in resuscitating “long duration assets” of all kinds. Within financial markets, aggressive growth stocks in popular sectors such as technology were pumped up to dizzying heights. Their fall from grace has been harsh and swift. With the prospect of the entire yield curve shifting upward, this does not bode well for those seeking a near-term recovery.

  • Meanwhile, back home on the ranch, labor costs are resetting aggressively higher. Factors including COVID-enduced worker shortages as well as bringing manufacturing home from overseas is all having an impact. Labeled the “Great Resignation,” many are changing careers and pursuing far more lucrative compensation arrangements.

  • In this brave new world of higher prices just about everywhere we look, stoked by higher labor and energy costs, investors must reassess several key decisions that are being redefined in this new economic background:

  • Bonds as ballast? Maybe not for quite a long time… rising rates across the curve appears to be signaling the end of the epic bull market in bonds. As an alternative, investors may consider dividend-paying equities, or even hybrids like high yield bonds and emerging market debt.

  • Real assets - such as real estate? Often viewed as an inflation hedge, real estate valuations have already exceeded our wildest expectations, and will behave like long-duration assets… not a good thing as rates rise.

  • Growth stocks? Companies with negative earnings and only pipe dreams of huge rainmaking opportunities years into the future are likely to trade at depressed multiples moving forward. This means many of the once glamorous technology stocks have yet to find a bottom.

  • Last but not least… crypto. No comment…

So what do we like? Quality companies with real earnings, strong balance sheets, and pricing power. We currently favor sectors including energy, financials, materials, consumer staples, and commodities. We are also increasingly bullish on international markets, including emerging markets.

In summary, patience built around preparation and an ability to remain nimble will be the deciding factors between success and failure in these volatile times that are likely to persist.

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