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INVESTMENT STRATEGY QUARTERLY

Letter from the Chief Investment Officer

A Time For Finesse

Are you ready for some football? Not American football, but global football—otherwise known as soccer! For the five
billion spectators awaiting the start of the 2022 World Cup in Qatar this November, the sport is the epitome of speed
and agility. But for the players on the 32 participating teams, it is so much more. The deceptively simple-seeming
game requires years of training. It goes beyond the fundamentals of ball control to pitch awareness, anticipation,
and making the right decisions under duress quickly. It is knowing when to dribble or pass, press or contain, and
shoot with power or finesse.

Like soccer fans following their favourite players, investors have no A balanced defence is imperative in the World Cup—and in man-
small amount of anticipation, if not angst, about every move cen- aging portfolios, too. Yet there have been few investments that
tral banks are making on the global economic playing field. In this have not been penalised as both the bond and equity markets have
intense time of soaring inflation and interest rates, what is the Fed- been sidelined with painful losses. In fact, the correlation of bonds
eral Reserve’s (Fed’s) game plan? How aggressive will it be? Can it to equities is the highest we have seen in nearly 25 years. Going
dribble cautiously down-field, carefully containing rising prices, or forward, however, bonds ought to provide some defensive buffer if
will it play a high pressing game that kicks the economy into a pun- yields fall amid a struggling economy. Importantly, yields are attrac-
ishing recession? What, for that matter, is the game plan of other tive for the first time in years in both Anglo Saxon markets as the
systemic central banks, especially in Europe? As the markets recal- economy slows and inflation, hopefully abates. Note that, in the US,
ibrate expectations and evaluate the plethora of risks on the field, Treasury yields historically tend to peak near the end of the Fed’s
this is a high-pressure time that requires finesse. tightening cycle. High quality Treasury securities and municipal
This autumn, all eyes will be on one perennial superstar, the Fed, as bonds remain compelling, but the inverted yield curve and the
it pursues its goal of winning against inflation. In the World Cup, the potential of a recession place riskier high yield bonds and emerging
top scorer gets the coveted Golden Boot award. If there was an market bonds offside.
award for tallying interest rate hikes, the Fed, one of the developed We are approaching half-time in President Biden’s term, with mid-
economy central banks, would definitely be in contention this year. term elections just around the corner. At this point, we expect
But for many investors, the goals are slightly different: to control Congress will be split. The Republicans seem likely to take control of
inflation and keep the economy growing—in other words, a more the House due to the historical precedent of the incumbent party
delicately balanced approach that requires finesse and a sense of losing seats; current polls suggest they just need to ride out the clock.
the economy’s field position. On the other hand, polls slightly favour the Democrats retaining con-
By raising rates into restrictive territory (>2.75%) to cool inflation, trol of the Senate in what appears to be another nail biter. With
the Fed may have put the economy offside—if not actually scored gridlock on Capitol Hill, the Biden Presidency will become a game of
against itself. It is surely not alone. Rapid-fire, heavy interest rate two halves as major game changing legislation is unlikely to be
hikes may not exactly be a winning strategy. In soccer terms, the passed. If so, political policy risk (specifically the potential for
Central bankers’ fancy footwork may end up tripping the economic increased taxes) will be reduced until the next election cycle.
expansion. The further the Fed raises interest rates above 4% (our The equity crowd has been hushed, stunned as stocks have suc-
forecast is 4.5%), the greater the probability of a recession. A similar cumbed to a bear market (a decline of more than 20%). Significant
outcome would surely await the UK economy too. As a result, our injuries have hampered the markets—rising inflation, higher
official call is for the US economy to experience a mild recession interest rates, a stronger dollar, and tumbling earnings growth revi-
starting early next year (2023 GDP forecast: -0.5%) and the UK sions. But those realities are likely already priced into the market
economy to contract from this quarter. Also, we’re issuing three and the volume of the equity markets’ vuvuzela (traditional World
yellow cards (or warnings for potential downside risk) for a lack- Cup noise-makers) may soon increase—rallying a turnaround.
lustre housing market, elevated energy prices, and weak consumer
sentiment.

Investment Strategy Quarterly is intended to communicate current economic and capital market information along with the informed perspectives of our investment professionals.
You may contact your wealth manager to discuss the content of this publication in the context of your own unique circumstances. Published 04/10/2022. Material prepared by
Raymond James as a resource for its wealth managers.

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