The third quarter of 2022 kicked off with a deceiving rally. This rally was led by encouraging new data, including declining energy prices, better than expected reported earnings, and language from the Federal Reserve (Fed) that led hopeful investors to believe that the Fed would begin to pivot away from its aggressive policy stance easing its pace of rate hikes and become more accommodative in its policy decisions to support economic growth.
However, the tides changed quickly as Federal Open Market Committee (FOMC) members strongly pushed back against this narrative and emphasized their commitment to fighting inflation despite weakening economic conditions. Stocks and bonds subsequently reversed and turned lower as investors reassessed the path of future monetary policy.
As the current landscape evolves, investors are still left with many uncertainties that make for a challenging market environment. However, a recent MoneyTalk interview with TD's Chief Investment Strategist for U.S. Wealth, Sid Vaidya, highlights the key factors driving markets and provides some guidance on how and where to stay focused.
Monetary Policy
In the interview, Sid classifies key market factors into two main categories, factors that will ultimately determine the path of monetary policy and factors that are directly impacted by monetary policy. The first set of factors to watch for are "inflation, jobs and wages, and inflation expectations." Sid stressed that these are "the number one focus for the Fed."
The second category of factors which are directly impacted by monetary policy are "economic growth, earnings growth, and the impact on credit markets," Sid explained.
While there have been some encouraging signs that inflation and wage growth are beginning to moderate, it may take some time before prices and salaries begin to normalize. In the meantime, the Fed is making efforts to soften demand to bring inflation down to their 2% target. The byproduct of this, however, is slowing economic and corporate earnings growth.
What about that recession talk?
And in the face of slowing growth, a key question on many investors mind right now is are we heading for a recession?
The word recession can be a scary one for any investor to hear. However, Sid offers some sound advice for investors on this front. He suggests "don't focus so much on whether we get a recession, or don't get a recession, [but instead] prepare yourself for slowing growth" and to "position yourself for that type of environment".
As the economy slows and uncertainty rises, it is important for investors to be cautious, and selective in their investment decisions. Companies that previously benefitted from a lower interest rate environment and strong consumer demand will face new challenges as the economy contracts. "You want to focus on high quality" Sid stated in regard to the impending market headwinds "and what I mean by high quality is resilient companies that have strong balance sheets, cash flows, earnings and dividends that are going to continue even in this type of challenging environment".
It is also important to remember that the challenges we are facing in the U.S. today are not isolated circumstances unique to the U.S. Elevated inflation, supply chain challenges, and slowing growth are issues that most of the developed world is currently facing. Europe, for example, is facing particular difficulty due to their strong dependence on Russia and Ukraine for energy and agricultural commodities. The war has created significant supply dislocations putting more upwards pressure on energy and food prices. Relative to Europe, the U.S. is much more insulated from the effects of the war and therefore the risks for the economy are far greater in Europe.
So, how does one position their portfolio armed with this knowledge? Sid Vaidya provides some insight on how U.S. Wealth is currently positioned. "On the fixed income side, we [are] focusing on high quality with exposure to treasuries, investment grade bonds, as well as municipal bonds" Sid explains. As for equities "we have a preference for U.S. over international – and we would suggest that investors tilt their portfolios to high quality value as well as dividend growth strategies".
Most of all, it can be helpful for investors to maintain their focus. In times like these, it's easy for investors to get caught up in the latest headlines and market noise, but it's important to remember that this day-to-day noise is just one stretch of a long journey towards reaching your investment goals. Investors who can ignore the market noise and focus on the long-term are more likely to arrive at their goals.
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