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At one extreme, we have the “soft landing” advocates, those who believe that the Federal Reserve (Fed) has done enough to curb inflation and will soon be able to cut interest rates, allowing the US economy to avoid recession. The other contrarian believes that the Fed will continue to raise interest rates and indeed may have already raised them too far, suggesting that recession is now inevitable. Where one sits on that spectrum of expectation determines how one’s portfolio should be positioned.
For us, at the risk of repeating myself, a recession is likely, but the timing is uncertain because of the strong US labour market which is still sitting on a great deal of pandemic savings. But that does not mean we are changing your portfolio strategy. In a market seemingly obsessed with a binary outcome (recession/no recession), we believe that the future path is likely to be more nuanced.
As regular readers will know, we are great believers in the power of portfolio diversification over the long term. Granted, diversification did not work in 2022 due to the drastic regime change and shock to financial markets caused by high inflation and higher interest rates. Nonetheless, the empirical evidence that diversification works over the long term is clear and we recognise that investing (as opposed to speculation) is for the long term. In fact, the longer one stays invested, the more likely it is one makes money.
Bearing this in mind, we are “sticking to our knitting” and ensuring that client portfolios are well spread across asset classes, geography, size of company, industry and style. Given that the near-term outlook is very uncertain, we firmly believe that this is the right thing to do.
For now, all eyes are on the US earnings season, which kicked off in earnest last night with Microsoft being the first of the mega-cap technology companies to announce results. The bar set by analysts was quite low, given employee lay-offs and the difficult-to-call economic outlook, and Microsoft narrowly beat expectations on most earnings metrics. However, margins were lower than forecast. Whilst the Q4 earnings season is still young, results so far have underwhelmed the market and company messaging is increasingly acknowledging the heightened macroeconomic uncertainty and risk of softer consumer demand.
Elsewhere, US manufacturing purchasing manager indices (PMIs) which are seen to be a leading indicator of economic health came in narrowly higher than expectations at 46.6 versus a forecast of 46.3. However, this is well below 50, which is generally accepted to be an indicator of an oncoming recession. Services PMIs also beat expectations, coming at 46.6 versus 45.3 but, again, well below 50.
As I have said before, during times of uncertainty, we don’t think it wise to take large “bets” in portfolios. Investors, in our opinion, would do well to sit on their hands and see how the next six months play out.
Until next time stay well.
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