Economic Cycles and Your Investment Strategy

Written by findfinanceanswer

Investors understand that Fed policy decisions affect the markets, and while the Fed has come a long way in clearly communicating its intentions since the Greenspan era, the calendar is perpetually full of scheduled data releases, each viewed as another piece of the puzzle the market is trying to correctly predict in real time.

Inflation is arguably the hottest topic of discussion now, and rightly so, after all it affects the Fed’s interest rate policy decisions, which in turn directly or indirectly affects nearly every other aspect of the capital markets.

For the average investor, these are often nervous times because they are weighing the need for income or growth against risks such as rising interest rates, market volatility, and the potential that their current portfolio of investments will perform poorly with the turn of the next data point released if that data point shows a hotter level of inflation or worsening supply chain imbalances.

Even the argument that inflation is here and rising on a long-term basis vs. were seeing inflation but it’s likely caused by the gradual economic reopening vs pent up consumer demand for such large ticket purchases as autos, homes, appliances. Etc., thus as pent-up demand is satisfied the inflationary environment will subside.

The market gauges expected inflation largely by the 5-year Breakeven Inflation Rate

While the 5-year BIR clearly shows the market’s expectation for average inflation over the next five years is at its highest level since 2008, periodic excessive market volatility attributed to the inflation issue will likely remain until enough pieces are added to the puzzle for the market to accept that we are likely to experience 2.5-3.0% inflation for some time, rather than runaway inflation triggering the Fed to make aggressive policy moves and chocking off future economic growth, that said, it is entirely possible that the puzzle develops to reveal more persistent inflation than is our current view, which would certainly cause us to pivot away from certain portfolio investments such as growth stocks in favor of inflation helped assets such as REITS, and value stocks.

Keep in mind that the Fed’s two primary tools are asset purchases and short-term interest rates. Given the April jobs miss, we can assume that on short-term rates we’re going to see lower for longer and the Fed will hold off on rate hikes near-term, but it doesn’t necessarily mean they’re going to refrain from tapering or slowing asset purchases. Tapering has implications for Treasury bonds, housing, the mortgage markets, and is still likely to begin by late third or early fourth quarter 2021. Right now, the bond market is pricing in a first rate hike for December 2022, but the jobs report makes it much more likely the Fed holds off on rate hikes. The Fed’s language continues to suggest to us that sometime in 2023 is more likely.

The problem is that the Fed has an almost perfect history over roughly 40 years of holding off on rate hikes while the market has long priced them in, only to play catch up and over tightening even after the bond market screams stop! The risks to overtightening are obvious – chocking off economic growth concurrent with high interest rates – a difficult situation for investors.

Given economic cycles have been established and repeated for a very long time it would seem that any investment program worthy of your consideration should either have a mechanism for recognizing economic cycle pattern behavior and adjust accordingly as cycles develop, or be run by professionals who will make the appropriate adjustments to keep portfolios “tuned” to the environment, the idea here is called tactical management and its goal is to make hay while the sun shines, while posturing the portfolio more defensively at such times that the system’s signals deem appropriate.

Alpha Fiduciary uses software to help it recognize pattern behavior across markets that may be indicative of cycle turns or inflection points in the financial markets, indicating tactical portfolio changes to help us stay opportunistically postured in our client portfolios at times that our systems deem this exposure to be best, while always watching for changes in markets that may require some tactical reduction or redirection of risk exposure to protect portfolio capital when its deemed best to do so. In short, our process is designed to help keep portfolios both durable and resilient.

As experienced portfolio managers who have managed wealth thru many economic cycles and corresponding financial market turmoil, we believe durability and resilience are the two most important qualities a portfolio management process should impart.

If you believe your wealth management process lacks durability and resilience or find yourself concerned about your portfolio when thinking about the economy and its future direction, we’d be happy to review your current portfolio to provide a second opinion to help you fully understand if your portfolio is designed to likely meet your needs today and over the long run.

Scottsdale Wealth Management, we are Alpha Fiduciary. We can be reached at 480-505-4033, or you can email [email protected], you may also schedule a conversation with us at and click the schedule an appointment link.

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