Global Market Strategist Brian Levitt discusses U.S. Federal Reserve policy and what he’s doing to prepare for what may come next.
People are always asking me what keeps me up at night. I had never imagined that my circadian rhythms would be of interest to people. However, that’s what people want to know when you spend most of your adult life as a bullish market strategist. Inherent in their questions has been the belief that I had been too Pollyanna about equity markets and that something was lurking around the corner to derail the market. In the 2010s, I had my prepared response of, “not much.” A decade of modest growth, benign inflation, and accommodative monetary policy had me sleeping like Rip Van Winkle. Occasionally I would throw in a joke about having young daughters who kept me up at night but that quickly ceased being an issue. Thanks, Dr. Ferber.
I was able to rest easy armed with the best advice I have ever received in this industry: Don’t fight the Fed. The market could ultimately take all the things that kept most everyone else up at night —elections, government shutdowns, trade wars, regional strife, even pandemics — so long as the U.S. Federal Reserve (Fed) kept policy conditions easy and stood ready to come to the rescue in adverse environments of the economy and financial markets. It became such a powerful force behind markets that it even got a name, “the Fed put.” In short, the Fed had become so proactive in halting excessive market declines that they were seen as insurance against losses, like a put option.
As such, I evolved my answer over time from “not much” to a less-flippant response of “a prolonged period of high and rising inflation, resulting in meaningful policy tightening by the U.S. Federal Reserve.” It felt like a harmless retort. After all, the structural forces in the economy — aging populations, globalization, automated workforces, personalized medicine — suggested inflation could remain relatively benign for much of the rest of my career, if not my life.
What’s different today?
That is, until a reopening from a pandemic resulted in massive pent-up demand being unleashed on an economy before the inventories were rebuilt and the workers returned. You may suspect now, with inflation at 7%1 and the Fed signaling four interest rate hikes in 20222, that I’m sleeping less restfully. Alas, you would be right. High and rising inflation and policy tightening hasten the end of market and business cycles, plain and simple. As the late Economist Rudi Dornbusch of MIT quipped, none of the market cycles of the second half of 20th Century “died in bed of old age. Every one was murdered by the Federal Reserve.”
Don’t get me wrong. This can still work itself out. Consumers are already balking at higher prices.3 A pending slowdown in demand could go a long way toward fixing those supply-chain challenges. The pandemic could become more endemic (more manageable with greater population immunity) and result in people returning to the labour force. A meaningful moderation in inflation could have the Fed backing off their tightening stance in 2023, and the cycle continuing.
What I’m doing now
For now, I am determined to not fight the Fed. I’m bracing for heightened market volatility and significantly more modest market returns. Nonetheless I still favour equities but will be positioned for the slowdown that the Fed is seeking to engineer, complete with higher quality, more defensive equity exposure. The way I see it, investing in highly speculative stocks was for last year.
And I’ll watch for signs that the cycle is coming to a premature end. Persistent inflation despite policy tightening. That would be my nightmare.
1 Source: U.S. Bureau of Labor Statistics, 12/31/21. As represented by the year over year percent change in the US Consumer Price Index.
2 Source: Bloomberg, 1/14/22. As represented by the Fed Funds Implied Rate. 3 Source: University of Michigan, 12/31/21. As represented by the Buying Conditions for Large Household Durables survey.
3 Source: University of Michigan, 12/31/21. As represented by the Buying Conditions for Large Household Durables survey.