Road Hazards

5/8/2023

The Federal Reserve managed to steer our economy into a tight bend of non-transitory inflation. Now the Fed is trying to correct its path without losing control. The markets look on aghast. Some key spectators remain optimistic that there will be no major accident. Even if that optimism is borne out, the debris already kicked up will take time to clear.

We too are observing this white-knuckle ride closely, aware that we are standing close enough to be caught up in the drama. It is still too early to say what damage will be done, although we do have confidence that the vehicle of the US economy will eventually get back on the road – and hopefully with a more careful Fed behind the wheel.

The Fed’s approach to the economy over the last ten years will be judged in time, but it seems to have been based on short-term solutions which generated longer-term problems. A period of historically low interest rates, followed by a complacent view of major inflationary forces, has required a pace of interest rate increases unknown for a couple of generations. Even the more mature members of our firm struggle to remember anything quite like this. The specific effect of all this for each individual investor is impossible to predict. There are, however, some broad messages that remain relevant.

First, successful investing should be in the context of long-term objectives and a clear strategy. We need to look no further than Warren Buffett to see the remarkable success achieved by being a dull investor who has conviction in the continuing success of the US economy. The Fed’s recent policies are troubling, but Buffet is not making wholesale changes to strategies designed to pass the test of time.

Second, interest rate changes are causing market dislocations. Most publicly, this has exposed the poor management of certain regional banks. At the same time, changes in lending practices are underway. This will impact businesses, especially in the property sector. As these effects ripple through the economy, there will be casualties, risks, and opportunities. There are signs that the real estate and private credit sectors are already being affected. We are watching developments closely with a mind to identifying investment opportunities.

Third, at a tactical level, this is a time for care and caution. If an investment strategy calls for investing money in the equity markets, then following a steady, disciplined schedule is critical, and this approach should be consistently checked against market developments. The short to medium liquidity needed for each individual investor should ideally be shored up to ensure that there is no forced selling if the equity markets fall abruptly. Finally, active cash management is a must in an interest-rate environment which has restored opportunities to earn something on your money.

Historians will eventually catalog the Fed’s recent decisions. Such records may be met with skepticism. Could capable people tasked with maintaining low, stable inflation really have implemented such policies? We know it to be true.

Richard Rushton