Navigating Markets Amidst Shifting Paradigms

By Mark Zhuravlev, CFP® on January 26, 2024

At Feinberg Stein, our investment philosophy is rooted in vigilance, adaptability, and seizing opportunities presented by market dislocations. In recent months, our focus has been on short-term treasury bonds, whose yields reached two-decade highs. We’ve reinvested proceeds, constructed income ladders, and positioned for future maturities, all while keeping a keen eye on companies with a “Competitive Edge” that can weather economic headwinds.

Liquidity at the Front Seat

To understand the current market dynamics, let’s glance back in time. Following the Great Financial Crisis, we experienced 12 years of robust growth primarily fueled by a low-interest rate environment. Cheap access to capital, combined with substantial money printing and consistent inflation of around 2%, propelled the S&P 500 to a remarkable 400% increase. ^[1]

However, the global pandemic disrupted this paradigm. The Fed and the government responded with unprecedented stimulus measures, flooding the economy with liquidity and driving swift market rebounds.

See the chart below of the M2 Money Supply Measurement (Liquidity) and the S&P 500 Pricing and their relation in the last 3 years:

The initial plunge caused by pandemic-induced lockdowns was reversed, but the underlying issues remained unaddressed. The Fed had utilized nearly all its monetary control tools: rate cuts, balance sheet expansion, and lending facilities, leaving little room to tackle inflation effectively.

The strain was evident as banks, over-leveraged and struggling, faced failures. Households grappled with inflation-eroding savings and lagging wage growth, which placed many in challenging positions. Loan availability dwindled, impacting the average consumer’s ability to access credit. The interest rate squeeze has wide-ranging consequences, making homeownership unattainable for most Americans.

The financial sector’s turmoil and banks’ failure prove that the worst may still come… The biggest economic challenge in the US by the Fed, Treasury, and Administration is not avoiding damage (which has already been done) but minimizing it with the few tools they have left.

Feinberg Stein Market Note, March 2023

Recession or Stagflation?

A worse scenario for the U.S. and global economy is stagflation. A period of slow economic growth (recession) usually with higher unemployment amid rising costs and prices (inflation).

Feinberg Stein Market Note, June 2022

In 2022, the US experienced two consecutive quarters of declining GDP, a typical indicator of a recession.^[2] However, the unique circumstances surrounding the pandemic, including the rapid layoffs and rehiring of jobs, have clouded traditional recession definitions. Nevertheless, jobs remain below pre-pandemic levels, and economic growth is stagnating, which is usually indicative of heightened volatility and risk.^[3]

Our portfolios have been positioned for a recessionary environment. Now, we shift to a stagflation-averse portfolio.

Feinberg Stein Market Note, August 2023

In the coming months, we anticipate a gradual decrease in inflation, although not quick enough for proactive Fed actions. Elevated interest rates will persist for several quarters, impacting sectors like real estate, where sellers hesitate to accept lower prices and buyers resist higher interest rates. The previous decade of steady growth made many forget the prolonged high-interest rate environment of the 80s.

Global Risk Increases

Outside of the US, the world is still in a state of unrest. The situation in the Middle East dominates global attention, with its intensity steadily increasing as more nations become entangled from all sides. Simultaneously, the Russo-Ukraine conflict remains unresolved at NATO’s doorstep, prompting preparations for potential defense. Further complicating matters is the recent blockade of the Red Sea, significantly disrupting international trade routes. Lastly, the OPEC+ alliance is actively driving up oil prices for its own benefit and exerting pressure on Western allies.

All of this unfolds against a backdrop where the rest of the world grapples with severe economic challenges such as inflation, fiscal devaluation, and deepening political polarization – placing a heavy burden on the working class.

Adapting to Volatility

Higher volatility necessitates more dynamic portfolio management. We continue to focus on Competitive Edge companies with strong balance sheets and dynamic management teams. Simultaneously, we explore opportunities in individual bond markets to develop our ladders further.

Looking Forward

As we enter an election year, market volatility is likely to increase. A summer boost in equity markets might occur, but we remain concerned about the potential for deflation if the economy experiences a “hard” landing. Deflation, characterized by falling prices, is a more severe concern than inflation, as it can lead to interest rates reaching zero, rendering the Fed powerless and triggering a decline in employment and overall growth.

However, there is optimism on the horizon. The pandemic spending includes allocations for infrastructure development and the expansion of chip manufacturing in the US. We are still amidst a technology revolution that promises a brighter future.

In the ever-changing landscape of the financial markets, our commitment remains unwavering. We are dedicated to proactive and vigilant management, ensuring your investments are well-positioned to navigate these shifting paradigms and seize emerging opportunities.

As always, we remain nimble and proactive in managing your life savings.

Best,

Joseph Feinberg, Tamara Stein, and Mark Zhuravlev

[1] FactSet
[2] BEA
[3] BlackRock, Global Outlook, “Stealth Stagnation” (2023)