Fed Policy Change Designed to Break Current Economic Expansion
Business cycles are intervals of expansion followed by slowing growth or a recession in economic activity. These cycles are driven by many macroeconomic factors, but our government policies serve as the governor to the economic engine.
Current Fed policy measures are being implemented to break the current economic expansionary phase of this economic cycle. Yes, the Fed wants to break this exuberant economy and slow it down to mitigate the pressures of accelerated inflation. With the government actions to save us from COVID the economy has been running too hot. 500,000 new jobs created in January followed by 300,000 new jobs in February with 10.8 million current job openings posted the Fed has no choice but to take aggressive action to normalize growth and purge excesses from the economy.
Warren Buffet said it best about the effects of such measures: “It is at these times that when the tide of economic expansion runs out to sea we see who is swimming naked.” When liquidity, or access to capital, is fluid and cheap all kinds of companies thrive. When capital is pulled from the economy and becomes expensive profit margins suffer. Strong businesses with sound fundamentals survive while the weak and unproven enterprises perish. This is why I have always professed that we invest in proven enterprises with strong economic fundamentals.
The first to break under these new market conditions is the crypto market participants. Last year while attending a community gathering a gentleman asked Congressman Guy Reschenthaler what he thought of Bitcoin? The gentleman also suggested that the dollar ultimately would lose it’s reserve currency status. Looking around the room the Congressman deferred the question to me. I commented that while the cryptocurrency technology is a creative tool, it could never replace the dollar given it is not regulated nor backed by any tangible assets. Since that meeting the dollar has strengthened and cryptocurrencies and everything associated with them has fallen in value. In fact, many of the largest crypto institutions have been exposed to just be downright fraudulent. As it has permeated the world economy under the Fed’s new contractionary measures the unproven, unregulated, unsafe and deceptive cryptocurrency operations are the first to fall and disrupt the markets with the failure of the Silicon Valley Bank and Signature Bank. And while speculation and poor risk management are not exclusive to these entities, the banks that failed over the weekend have a unique exposure to highly speculative and risky depositors such as early stage venture capital, crypto, and technology companies. The average traditional bank has 4 times the amount of insured deposits that Silicon Valley Bank had and much more conservative counterparties.
Sensing the future effects of raising rates last fall we took profits in growth stocks and moved the portfolios more towards value-oriented stocks. For those that have a more balanced portfolio, we took those profits and found attractive fixed income opportunities. You may take comfort in knowing we are principally invested in proven enterprises that are primarily in large capitalized companies and each of you have a well designed plan with excess cash and cash flow to ride out the current economic storm. This environment will present opportunities and validates our conservative investment management program.
As you face a storm you do not attempt to outrun it. You must face it head on with calculated precision. We have positioned our portfolios and family financial plans to survive and thrive. Those that invested in unproven enterprises will perish. Once the Fed stimulates the economic engine and the fundamentals return to some normalcy trends, the new expansionary growth cycle will begin.
In closing, I expect 2023 to be a year of transition. I would anticipate the beginning of the next economic expansionary phase to begin after the next presidential cycle in late 2024 and given the elevated debt around the world, annualized growth rates will be subdued. Despite this challenging environment, our portfolios are positioned to generate cash flow by focusing on dividend paying equities. For those that hold a bond allocation, we have elevated the quality of our bond holdings while lowering our duration risk or sensitivity to interest rates. We don’t own speculative stocks or newly formed companies that have never been through a recession. Instead, our focus has always been on large capitalized companies that are proven and have attractive balance sheets. These are companies that have been through many market and economic cycles and are able to ride out the storm.
Commentary Disclosures: Covington Investment Advisors, Inc. prepared this material for informational purposes only and is not an offer or solicitation to buy or sell. The information provided is for general guidance and is not a personal recommendation for any particular investor or client and does not take into account the financial, investment or other objectives or needs of a particular investor or client. Clients and investors should consider other factors in making their investment decision while taking into account the current market environment.
Covington Investment Advisors, Inc. uses reasonable efforts to obtain information from sources which it believes to be reliable. Any comments and opinions made in this correspondence are subject to change without notice. Past performance is no indication of future results.
