What now? Sorting and restructuring
Introduction
Okay, so the debt default crisis didn’t happen. Was that a near miss, or was it never actually in doubt? The whole situation was framed from the outset as our next grave calamity – the one that just might finally ruin it all. If you are someone who sees everywhere disturbing evidence of societal demise, then the fearfulness of this recent narrative probably resonates. The neurotic and angsty bond market further reflected these sentiments. But the stock market? That glib forum of optimists and dreamers? Well, it never really looked that scared. Which view is correct (or more correct)? The media, in this case, seemed to alarm rather than inform. After all that has transpired in recent years, it pays to be skeptical and rational.
Sorting, Restructuring, and Realignment
These are probably not times of either/or, decline/renewal, down/up. In my view, we are still experiencing the follow-on impacts of the pandemic shutdown and reopening. These eroding aftershocks are playing out as broad restructuring across all sectors and categories of the global economy. And as things are sorted and realigned, there will be winners and losers. Let’s consider some of the areas being transformed:
Global Supply Chain. The pandemic revealed that the myriad systems of outsourcing, offshoring, shipping, and logistics were in fact quite fragile and vulnerable, if low in cost. This vulnerability was news to many of us. Now, production and delivery systems are evolving and being redesigned to prioritize resiliency and durability, in addition to cost.
Job Growth. Wages and hiring have been persistently strong throughout the Fed’s rate hike campaign. This belies assumptions of a pending recession. The mixture of job growth or shrinkage has been very different from earlier periods such as 2020 or 2008-2009. Currently, job losses have skewed white collar and white male, and in the sectors of in technology and finance. There has been job growth among African American workers and women, and in in travel/leisure, hospitality, and other services. And, in the spirit of skepticism: the recent media reports about mass layoffs in the tech sector while true, don’t provide the context that the total absolute number of these layoffs is small relative to the overall labor market.
How we Work. The pandemic radically changed the way work is done in the US. Now, depending upon sector, employers must offer greater flexibility in terms of remote options, flexible hours, and other accommodations. This creates both positive and negative impact on things like workplace culture, satisfaction, training, mentorship, compliance, etc.
Transportation. The transition to electric vehicles (EVs) gathers momentum, raising problems as well as opportunity. Many US states and other countries are implementing target phaseout dates for fully gas powered vehicles. This has huge implications for the infrastructure to support EVs and the sourcing/mining of materials to build out power grids and batteries.
Communication. Video conferencing on applications such as Zoom, Teams, and Facetime has been available for years. But it took the pandemic to bring it into widespread mainstream usage. The positive impacts on things like productivity and efficiency were initially obvious, but now many people and employers are confronting negative effects of excessive zoom calls such as worker isolation and burnout.
Tech and AI. We are entering into a period of transformation in technological innovation. Some see artificial intelligence (AI) as transformative as the introduction of the personal computer and smartphone. Some fear it as a force we won’t be able to control. Some have called it more A than I. Wherever you fall on this spectrum, it is clear that change is coming. It is worth noting that most, if not all, technological leaps in history were accompanied by great worry about their destructive impact. I’d suggest we look at this more for the opportunities these new tools offer to wise and emotive humans, than in a static sense of what specific job description might become obsolete.
Interest Rates. The low to zero interest rate policies that prevailed for many years are clearly over. This is having its intended consequences in slowing various sectors of the economy. Interest rate sensitive areas slowed first (housing), while other areas (labor market) have proved more sticky. The rate hiking has had some unintended destructive impact, such as the failures of banks like Silicon Valley Bank and Signature. However, this proved not to be a widespread banking crisis, but rather a stratifying or sorting of strong banks (large, medium, and small) versus vulnerable ones. It took rising rates to reveal flaws.
Housing. The housing boom of recent years has begun to abate. As always, real estate is a hyper local and segmented industry. There are categories, neighborhoods, and regions that continue to see sustained high prices, while prices are falling in other cities, neighborhoods, and price ranges. This probably means that short-term surges related to the pandemic are settling down. But housing supply remains low, which probably means support for house prices.
Global Alliances. China’s miraculous growth period has greatly declined, and factors such as demographics and overbuilding indicate that a near-term return to high growth may be difficult. China remains a massive economy and is establishing or asserting its prominence through alliances that may be counter to US objectives. Responses to the Ukraine/Russia war offer a clear example of this where countries like Turkey, India, and Iran are (each for their own reasons) choosing not to fall in line behind the US in opposition to Russia’s aggression. These alliances present an evolving set of geopolitical challenges and opportunities.
What does this mean for investors?
Volatility can be unsettling. For the past several months it has seemed like the markets have gone up, only to go back down, then back up again. This sideways action is what we had discussed in prior writings and client conversations. While it can be frustrating, it is important for investors to understand that all of the adjustments discussed above lead to many winners and losers as we iterate our way to an evolved and stronger economy. Stocks, bonds, and other investments are churning and grinding their way forward in reflection of these broader restructurings.
Inflation matters more than interest rates. I saw an excellent presentation a couple of weeks ago by a strategist from Fidelity who reminds us that inflation is one of the most damaging influences on long-term wealth creation. Interest rate policy, though impactful, is notoriously hard to predict accurately. And if you look at past rate hike cycles, the markets have performed very well once rate hike regimes have finished. On the other hand, times of persistent high inflation are almost certain to have a negative impact on stocks. This is made clear by the poor performance of broad stock market indexes during the high inflation period of the late 1960s through the end of the 1970s. The takeaway? The Fed is right to focus on inflation.
Conclusion – Times of Change
Investors need to remember that change presents both opportunity and decline. Where, we might ask, are the areas most likely to see benefit from all of the resorting, restructuring, and change we see all around us? We think long-term opportunity continues to exist in large US blue chip and technology companies. We also see potential in developed foreign economies and innovative growth areas in the US. And because of higher rates and the reset in bonds last year, traditional conservative bond investing is at last once again attractive.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.
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