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Out of pain comes a few attractive opportunities

Out of pain comes a few attractive opportunities

| September 29, 2022

After a brief Summer rally, stocks resumed their declines in September.  The optimism of easing inflation gave way to pessimism about higher interest rates -- essentially that the Fed was not yet ready to take its foot off the economic brakes.  

Inflation might be peaking

The Fed's zeal is a little surprising because signs of slowing inflation are all around us.  Clearly, higher rates are taking the froth out of the housing markets.  Used car prices are returning to normalcy, and crude oil / gas prices are back to pre-pandemic levels. At the same time, food prices have yet to normalize, and rent increases will be slow to flatten, lagging any moderation in property values.

Therefore, monthly CPI reports still show high inflation. But those numbers are lagging indicators, comparing prices today versus one year ago, not month-over-month. Slowing inflation, therefore, isn't yet obvious, and might not be slow enough to satisfy the Fed.

Is the Fed being overly aggressive?

In our view, the Fed seems to have a credibility problem and wants to show that it's now serious.  They were late to raise rates when the economy was roaring higher and housing prices were soaring, and now they may be late to take things a little slower.  The market is collectively saying, "Watch out, or you will cause more damage than you are hoping to correct."

Meanwhile, higher rates are attracting capital to the US dollar.  This will make companies' overseas earnings worth less in dollar terms, delivering a hit the bottom line of multi-national corporations in the short term.

Overvalued currencies ultimately correct themselves, potentially giving foreign investments with a wind at their back after years of underperformance versus US markets. Definitely something to watch...

Out of this pessimism comes opportunity

While we have recommended only modest exposure to bonds in recent years, yields are once again becoming interesting.  At the higher-risk end of the fixed income category, high yield debt (also known as junk bonds) sports yields in the high single digits (and occasionally double digits.)  

High yield is especially interesting at these levels for its eventual trajectory back to lower levels of rates and higher risk attitudes.  A hypothetical decline in junk debt yields from 10% to 5% could result in appreciation of 50%, or more, on specific instruments or funds.  This is an area of particular focus for our research as we seek to profit from recent dislocations.  

A time for Venture

While venture capital funds are very long-term investment vehicles with ten-year or longer lives, they have pronounced cycles that are based on overall valuations.  The recent downturn in equity markets has put pressure on VC multiples, like everything else.  For new funds, the likelihood that 2022 will be a good year to start one is now considerably higher than it would have otherwise been under more normal market conditions.

Over the many decades of measurement, venture capital funds have outperformed nearly every other asset class.  And despite their higher volatility, VC's low return correlation with listed equities makes them a good portfolio addition.  (Yes, adding a more volatile, but uncorrelated, asset can lower overall portfolio volatility.) 

We are now more active in this space that we have ever been, thanks to a new relationship with Overlay Capital, a specialist firm focused on impact-oriented alternative investments, including venture capital.  Overlay's VC funds are long-term investments for accredited investors, and that lack trading liquidity.  But today there are also conventional mutual funds that may offer the average investor options to invest in early stage companies.

Taking on more risk?

The common denominator here that when markets are weak, it often makes sense to increase one's risk profile to profit from a rebound (within one's risk tolerance, of course.)  Admittedly, stepping in front of a "light at the end of the tunnel" can seem like an approaching train. But cycles eventually run their course, and downdrafts like the COVID-19 bear market and financial crisis of 08-09 seemed intractable at the time and turned out to be great buying opportunities.  

Companies emerged from these periods still standing, and economies righted themselves. They will again.  The date of healthier markets has yet to be determined, and adding risk might not immediately look like a wise decision.  But that date will come, and positioning for it when spreads are wide and valuations low has historically made a lot of sense.

At the opposite end of the risk spectrum: An Inflation Bonus

US Government I-Bonds are inflation-linked Savings Bonds.  Each person can invest up to $10,000 (plus up to $5000 of a tax refund) annually.  The interest rate on these bonds resets every six months and is likely to earn you more than 9% for the next year.  

One has to make their purchases at the Savings Bonds website (, and there are restrictions on redemptions. but they are hardly onerous (forfeiting 3 months of interest when redeeming early.)  I-Bonds are definitely worth exploring versus bank deposits or CDs. They can't be held in a brokerage or investment account, however. 

If you have idle cash seeking a home, this is an unusually attractive option.

We welcome your comments and would be happy to discuss any of these topics with you.