INTRO
It’s never too early to talk about Powell Pivot #2. Powell Pivot #1 occurred late in 2018 when James Powell, the head of the Federal Reserve, decided to do a complete 180, and instead of selling bonds as part of their QT Program (Quantitative Tightening), they decided they needed to keep buying. The ““markets”” forced The Fed’s hand, as a three-month 20% market swoon (lower) was all it took. When the markets realized that the Fed realized that they were stuck in this inflate or die trap, they celebrated. The year 2019 was a year of celebration and realization, as most asset classes finished deep into the black with positive returns across the board.
Today, rates are once again on the move…higher. And we keep hearing people say that Powell will raise rates until something breaks. Of course, one can argue that something (many things) have already broken. But the narrow-based AI stock market rally powers on, along with the rate hikes.
Let’s build a plan in case we get a repeat performance. After all, we now have rates high enough to provide plenty of room to cut rates in the future. It is also safe to assume The Fed is not afraid to print more (increase their balance sheet) as this has been their main tool and response to most every market hiccup since they initiated their “temporary” response to the GFC (Great Financial Crisis) in 2008. Our plan will come in three parts: an allocation shift, a messaging component, and a shopping list.
AN ALLOCATION SHIFT: TAKING A BARBELL APPROACH
We favor a barbell approach to asset allocation to protect against both inflation and deflation. You can read about our multi-asset model portfolio here. Jim Rickards agrees with us in his recent article here, “A model portfolio could have gold, natural resources, and energy stocks as inflation hedges, with Treasury notes as deflation hedges, and a healthy allocation of cash between the two ends of the barbell to provide liquidity and optionality as conditions become more clear.”
Our multi-asset portfolio is balanced between inflation and deflation. If we see a market correction large enough to force a second Powell Pivot, we need to be ready to tilt our portfolio towards inflation. And because each successive QE announcement is larger than the previous, it is safe to say the next one will be pretty big. After all, the last one was tagged as QE-Infinity. Not sure what comes after that.
A fresh round of QE would require a meaningful shift in our portfolios in favor of inflation. Assuming our barbell portfolio is balanced (50/50) between inflation and deflation, the potential rebalance towards inflation would be meaningful. First of all, our portfolio will be out of balance in a large correction, since our inflation assets/allocation will go down and the deflation assets should outperform. Secondly, we would now favor something closer to 60% – 70% inflation, to use round numbers.
Asset allocation shifts of this size should be implemented over a period of time long enough to reduce the odds of a big bad mistake. Everyone has different sensitivities when it comes to markets and risk, so it is important to think this through prior. The less risky move is to spread our rebalancing strategy over a longer time horizon, while also using market prices as a signal (buying inflation assets into strength as a confirming data point).
#TTT (Trust, Truth, & Transparency)
Rates have been trending lower for decades. At the same time, the seeds of inflation have been sown since The Fed began their bailout programs in the ‘90s (emerging markets crisis along with the Long-Term Capital Management debacle). The inflation genie came out of the bottle post Covid due to the global response to the pandemic (money printers go brrrr….globally). Align with a trusted resource, influencer, or advisor that has a solid understanding of this inflation/deflation story. Do not be afraid to discuss this in the open. This is the messaging we refer to.
We are trying to protect against Mr. Market, who has a reputation of hurting a lot of people. And we also need to be aware of the fact that these inflation seeds have been sown for a long time. This is not a new phenomenon. It was only a few short years ago when inflation was POLICY! This is a concept for another day, but it is hard to get behind a policy which aggressively reduces the purchasing power of our currency. Be open to new ideas and discuss with friends and family because we are all in this together.
SHOPPING LISTS
We love lists. Let’s build our inflation shopping list. The inflation side of our multi-asset portfolio consists of stocks, hard assets, and precious metals (and Bitcoin if you dabble). Scrub through this group to see what looks good. Of course, things will change in the markets, as they always do, but it is up to us to be proactive and prepared. We make lists and update them on a regular basis. Add to favorites, add new names and new assets that make sense, and watch where the opportunities arise.
Do not rule-out “supplies” as an interesting inflation hedge, based on our conclusions in our 4-part series, “New Vol”. Our strategy of building personal resilience through the purchase of supplies fits squarely into the inflation side of the portfolio. This opens the door to a lot of new ideas.
CONCLUSION
Remember that our pivot scenario is predicated on a market correction. So by default the market will be more volatile, thus less liquid, thus more expensive to transact. Our best execution starts with a plan, and portfolio management is no different. Have your pivot plan ready, and hopefully we do not get punched in the mouth too hard.
