Portfolio manager gives his verdict on Fed's upcoming meeting and why now is a good time to address portfolio vulnerabilities
While there’s a growing consensus that inflation might be slowing, all eyes are still on central banks as concerns grow about what the Federal Reserve (Fed) may do next week since it still hasn’t reached its target rate for reining in inflation.
“If they get it under control in the next two months, we ought to expect signals from central banks as to how and when they can take their foot off the brake in terms of raising interest rates,” Michael White, portfolio manager for Picton Mahoney Asset Management’s multi-asset strategies, told Wealth Professional.
It’s still a delicate balance between economic growth continuing to slow, but not becoming recessionary.
“It’s really up to the Fed to manage those expectations in the next two months,” said White. “Our base case is that economic growth will moderate. Basically, what we’re seeing right now is a manufacturing recession, akin to what we saw in 2019. So, it’s not a broad-based recession. But, to the extent that the service economy could react to more hawkishness and slow to anywhere near the same extent as the industrial economy, then you’d have a broad-based recession. So, right now, I think the service economy is pulling a lot of weight and we are still putting our odds in favour of the broader economy and having a soft landing.”
While the markets have priced in most of the anticipated hikes, White expected next week’s announcement to be accompanied by the Fed message that it will be data dependent going forward. He anticipated that it could say: “We’re no longer going to be pressing ahead with very hard and vigorous hikes. We will now wait to see what the effect the past hikes have on the economy and monitor and apply accordingly.’”
Given the fact that, despite the recent rally, volatility will probably return more frequently, he suggested advisors reassess their portfolios to see what is happening on the up and down sides.
“It’s an opportunity to find those parts of the portfolio that have behaved with a little more volatility than they’d like,” he said, adding that the Fed may continue to be more hawkish, which could continue to impact markets. “Tactically, we have hedges in place for the downside, but we would be looking for economic growth to slow down. Our base case is a softish landing for the economy and a reacceleration for asset prices into year end. But, tactically, we’re still a little cautious.”
Given this year’s unexpectedly severe market shock to the typical balanced investor plus aggressively rising rates pushing bond prices down, White noted that multi-asset strategies have become a more popular option for advisors looking for better investment returns.
“This time really makes the case for a multi-asset strategies approach where you have more tools at play rather than just stocks and bonds. There’s certainly much more room for diversification benefits, much more room for hedging and risk management,” said White.
“Hedging is all about preparing for the risk rather than reacting to it. For us, having that risk management sensibility, it’s about hedging. Viewing certain markets for the risk reward potential they have and applying an insurance kind of mindset where we think there’s an opportunity to hedge a risk. So, you need to be willing to pay a premium, whether it’s on an option or some other form of protection, and be willing to pay that cost to protect a part of the portfolio that we might see as vulnerable or potentially risky. So, it’s about addressing those vulnerabilities in the portfolio while maintaining your diversification in it as well.”
White emphasized diversification so that “when asset classes are all misbehaving, you have the opportunity to add strategies that are uncorrelated and value added to the portfolio. So, diversification is not just about owning a bunch of different stocks or bonds, it’s about owning strategies that can help you mitigate volatility and lower correlation in a traditional portfolio.”
It’s been an interesting year and White noted that, coming into it, Picton Mahoney expected a lot of headwinds in the front of 2022 that could develop into tailwinds in the back half.
“We probably underestimated just how vigorous the equity market drawdown would be,” said White, “but we’ve been very pleased with the performance of our portfolios. So, that’s what’s keeping us busy right now: thinking about when the next tactical opportunity comes about because we would have hoped for clear signals by now.”