Home Finance It's Been An Interesting Year Already – My Thoughts Going Forward – Seeking Alpha

It's Been An Interesting Year Already – My Thoughts Going Forward – Seeking Alpha

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It's Been An Interesting Year Already – My Thoughts Going Forward – Seeking Alpha
Man leaning on wall looking out to sea

The Good Brigade/DigitalVision via Getty Images

The Good Brigade/DigitalVision via Getty Images
The purpose of this article is to discuss my current macro-outlook on the market. This includes a look at some of the headline risks, namely inflation, geo-political risks, and rising interest rates, and how best to manage these headwinds. Personally, I continue to have a positive bias on the market. While we entered 2022 I had some hesitancy due to elevated valuations and a general euphoric sense. Yet, we hit a meaningful correction in large-cap stocks already, offering an opportunity to put cash to work for those who had been patient. With some short-term noise behind us, stock prices are looking more tempting, but I think investors need to be more active this year than usual.
Inflation is not something we have had to prepare for in prior years, and even last year the red-hot readings left some thinking it would pass soon. That has not happened, so making adjustment to hedge against continuing inflation and higher interest rates makes sense. Further, while geo-political risks, especially in Eastern Europe, are an immediate concern, I would not let those developments impact my investment decisions. Finally, muni bonds have sold-off sharply. While I had begun to get more cautious on this sector last year, the recent drops have been too large for me to ignore, and I am once again bullish on that sector.
To start, I think it is very relevant to discuss inflation and how investors can cope with it going forward. This has been a hot button topic in 2021 – one that many market pundits and government officials got wrong for a long time. After re-hashing a “transitory” message for almost the entire year, despite little evidence to justify that position, Fed officials in particular finally took notice and have moved to a more hawkish stance since late Q4. While tapering is under way to help combat inflation, actual rate hikes have not started in the U.S. yet. Further, the expectation that the Fed is going to move on rates has done little to curb the supply-demand imbalance of just about everything we buy. As a result, CPI measures continue to come in red-hot:

US Inflation

Bloomberg

Bloomberg
My thought here is that this accelerating inflation path is not one that is suddenly going to reverse and nosedive south, even once the Fed begins to push up interest rates. While I do expect we will finally see some easing of inflation metrics as the year moves along, we have to remember that prices are up substantially already. So an “easing” of inflation from these levels still means prices will be high, and households/investors/consumers are all going to have to adjust to this reality for longer than they may have been anticipating.
With this in mind, how can we prepare? Myself, and plenty of other authors, have no doubt been covering this topic for a while. The key sectors/companies to focus on during inflationary times are those that can pass along cost increases to their end consumer. The basics here are places like Energy, Financials, and Materials. This is because these companies own those inputs that are rising in value, and can thus sell them at higher profit margins then before. In the case of Financials, this allows lenders to (hopefully) adjust their lending rates higher at a faster pace than their savings/liability rates. This improves their margins as well. Other consumer areas that focus on discretionary and luxury items that cater to a more affluent market segment can also benefit, as those buyers are less price sensitive.
Beyond these traditional areas, many investors opt for alternative asset classes to hedge against inflation. These types of assets usually come with more volatility and more inherent risk than large-cap sector-specific investing, but they can also be very useful and rewarding. Some areas here would includes precious metals (gold, silver, and copper being some of the most popular), Real Estate (commercial and residential), crypto-currencies, and other commodities like oil and natural gas, among others.
With these options, how best should investors prepare? I personally have been owning and recommending Energy and Financials for a while. It may be a bit late to the party to recommend these now, but I continue to see merit to owning/buying these sectors. That said, I would probably ladder in given the impressive runs both sectors have had, and look to add on weakness. In addition to those traditional plays, I am looking to build on my Real Estate exposure. This will be done primarily through commercial, office, and storage space REIT exposure, which will probably include from retail to if it cannot be avoided. The reason I like going long this sector now is because REITs actually have a very strong time-tested performance history during periods of inflation. While gold and other commodities can perform well too, their performance is more volatile and mixed. REITs, by contrast, have delivered more stable and reliable returns during prior inflationary periods, as shown below:

Inflation Hedges

CNBC

CNBC
Of course, within the world of REITs, there are a plethora of options. I would absolutely recommend picking out specific REITs that could perform well, if one has the time and inclination to drill down on individual holdings. I like storage/tower space, apartments, and commercial leases opportunities in growing areas. However, one ETF I have my eye on as the iShares Global REIT ETF (REET). While it is passive exposure, it diversifies my portfolio in a way some other REITs do not, in that it has about 1/3 international exposure. I like this concept, primarily because inflation is not a U.S. problem alone, it is a global phenomenon:

Global Inflation

IMF

IMF
The conclusion I draw is that international investors are going to be facing similar challenges as we are domestically. Inflation is a headwind globally, and I would suggest many foreign buyers are going to be little at Real Estate exposure as well. This is an area that has seen a sharp rebound from the depths of the pandemic, but is still lagging considerably given how hard it fell in 2020, compared to the broader market. So, in sum, I see relative value, foreign buying potential, and a good way to hedge against inflation.
* My personal holdings include Invesco KBW Bank ETF (KBWB), JPMorgan Chase (JPM), Vanguard Energy ETF (VDE), iShares Global Energy ETF (IXC), Mid-America Apartment Communities (MAA), and Sprott Physical Gold and Silver Trust (CEF), and I plan on initiating a position in REET.
Another headline that is more recent, compared to inflation, is the potential for military action in Ukraine. I will avoid discussing my personal take on the matter, as to whether the U.S. should have any involvement in this potential conflict, but rather focus on how investors may want to prepare.
In this view, the answer is simple. I would say – do nothing. Ultimately, there is not a lot investors can do to really prepare for these types of events. They may create volatility, they may not. If it becomes a minor conflict or contained regionally, the chances are we will not see much of an impact on U.S. indices. Therefore, I would not suggest selling/rotating out of any stocks or funds due to this headline and run the risk of triggering taxable gains for no good reason.
Of course, that is just my personal take. If one feels more comfortable reducing their equity exposure, or have some losses they want to realize, I would not presume to argue against that. Everyone has their own comfort level. But it is worth noting that in past flare-ups of this nature, markets often do not react negatively. And, when they do, it is only just a one-day drop:

Geo-Political Market Reactions

Charles Schwab

Charles Schwab
Again, my thought here is that long-term investors really should not be trading on these types of headlines. Can they impact markets? Of course. Will they meaningfully hurt earnings for large-cap U.S. companies? Probably not. If anything, this conflict could give a boost to the inflationary plays I mentioned earlier – such as energy, commodities, and other metals – which may see supply-chain issues and other restrictions if cross-border travel becomes impacted. I would not suggest buying these assets primarily for this reason, but I am suggesting that, if anything, conflict in that region could send some asset prices up, not down.
As my followers know, I shifted out of my fixed-income exposure last year with the exception of muni bonds. Even in that category, I reduced my exposure, simply because there was too much inflation and too much duration risk within these products. In hindsight, I am glad I did, as bonds did not really deliver much in way of returns and the risk-on mode sent equities markedly higher. The positions I did keep in munis suffered, and I had to take a long look at whether I should keep that exposure.
Ultimately, I did hold on to muni exposure, at about a 50-75% proportion compared to where I was when the year started (the range varies because it was different for each of the three muni funds I own). With Q4 and 2022 already starting to punish munis a little bit, I am actually viewing this weakness as a chance to build back up to full positions, rather than reduce my exposure.
The reasons for this are multi-fold. One, I don’t see a lot of value in treasuries or IG corporates, so munis with their tax-exempt income remain my preferred play. Two, since we can anticipate a Fed rate hiking cycle in 2022, it is worth noting that munis have out-performed treasuries in the two most recent Fed hiking cycles, as shown below:

Munis vs. Treasuries

BlackRock

BlackRock
This makes me confident that this is the right place to hold quality credit assets, given this historical performance gap.
Three, since the muni market has sold-off recently, new positions are starting to offer real value. If we look again at munis versus treasuries, we will how valuations have not been as attractive as they are now at any time over the past twelve months:

Muni Yield To Treasuries

Bloomberg

I look at this as confirmation that now is not the time to be selling. While the level of interest rate risk in the sector does concern me, it is difficult for me not to add at this wide of a valuation spread. Further, this valuation gap extends beyond just the muni index. While prices of the underlying securities have fallen relative to treasuries, investors have also been rotating out of the CEFs that hold this debt. The result from that has been an expansion of discounts for these funds, compared to their net asset value. In fact, all three funds that I own – the Nuveen AMT-Free Quality Municipal Income Fund (NEA), the Nuveen Quality Municipal Income Fund (NAD), and the BlackRock Taxable Municipal Bond Trust (BBN) all currently have discounts to their NAV. This again affirms that I want to be buying, rather than selling, at this juncture.

Bloomberg
Through this review, I hope to have offered some practicable advice on how to approach the next few quarters in 2022. Ultimately, I expect stocks to grind higher, but at lower returns than what we have enjoyed in the last three years. Generating “alpha” may mean taking some profits when they are present, and using those proceeds to buy back in when volatility eventually re-emerges. With a Fed rate hike cycle on deck, persistent worries on inflation, and a increasingly hostile political environment in Washington and abroad, we have to expect good and bad news throughout the year.
Case in point, depending on where you look right now, you could be feeling wildly bullish or pessimistic. As one example, consider that M&A activity soared to wrap up 2021, setting the stage for more corporate activity this year too:

M&A Deal Volume

Bloomberg

Bloomberg
This suggests an optimistic corporate environment, where lenders and large and institutional investors are seeing deals and acting on them. That is positive for the economy and for valuations. Yet, if we look elsewhere, we may be completely disheartened. For example, a recent poll suggests that an increasingly larger number of Americans are struggling to pay their bills:

Household Poll

Yahoo Finance

Yahoo Finance
My takeaway from all this is investors need to be prepared for the good and the bad this year. The economy is looking increasingly fragmented – there are sectors profiting from inflation, others are suffering. The corporate environment looks strong, but households are under pressure. The list goes on. We need to approach this year with a balanced mind, keeping cash on hand to be advantageous, and capturing some profits to protect those gains when things seem too euphoric. I believe the cyclical sectors I mentioned in this review, such as Energy, Financials, and Real Estate will all continue to generate gains, and I continue to like munis for my credit exposure. With this backdrop, I will be adding to all those areas on any forthcoming weakness, and suggest readers give this thesis some thought for 2022.
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This article was written by
I am a macro-focused investor, who has been in the banking industry for the past fifteen years. I am originally a New Yorker, re-settled in North Carolina. I have two business degrees (Bachelors/MBA). For pleasure, I’m an avid hiker and competitive tennis player. During my undergraduate years, I was a Division I athlete in men’s tennis at Binghamton University. 
Broad market: VTI; VOO; QQQ; DIA
Sectors: VPU / BUI; VDE/ IXC; KBWB; XRT; BJK
Non-US: EIRL, EWC; SCHE, SCHF
Dividends: DGRO; SDY, SCHD
Municipals/Debt Funds: NEA, NAD, PDO
Stocks: WMT; SWBI; JPM, MAA
Commodities: CEF, Bitcoin
Cash position: 10%
Disclosure: I/we have a beneficial long position in the shares of VOO, VTI, QQQ, DDM, VDE, BBN, IXC, MAA, NEA, NAD, JPM, KBWB either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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