Weekly Brief: Recession Is Now Our Best Bet For Bringing Inflation Back Down

Weekly Brief: Recession Is Now Our Best Bet For Bringing Inflation Back Down

over 1 year ago3 mins

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A better-than-expected earnings season has been overshadowed by still-high inflation and rising interest rates, leaving precious few investments for you to choose from.

🕰 Recap

  • Earnings season got underway last month, and companies have mostly done better than expected
  • That’s despite the latest US inflation data, which came in at a higher-than-expected 9.1% for June
  • That’s partly why the Federal Reserve (the Fed) increased US interest rates by another 0.75% late last month
  • And on Thursday, the Bank of England (BoE) followed with its biggest hike in almost 30 years

✍️ Connecting The Dots

The tried-and-tested way to get inflation to a more manageable level – generally around 2% – is to raise interest rates, which we’ve seen happening all over the developed world this year. The BoE and the Fed have announced rate hike after rate hike, and even the European Central Bank joined the fray for the first time since 2011, increasing its key rate to the eye-watering level of… 0%.

But central banks have a habit of overshooting the mark with their rate hikes, slowing down economic growth too fast and effectively triggering a recession. And it could be that recession, rather than the rate hikes themselves, that ultimately reduces demand for commodities and eases the pressure on supply chains enough to bring inflation down to 2%. In other words, the recession might be the fever we just have to go through to sweat inflation out of our system. The jury’s out on whether investors prefer that to an alternative scenario: if we don’t end up in an out-and-out recession that brings down inflation, we might find ourselves in a “stagflationary” environment of low growth and high inflation.

US companies have held up remarkably well considering the almost exclusively negative ways this could pan out: the majority reported better-than-expected quarterly earnings, and stocks have been rallying at the same time. But we’re still relatively early on in the rate-hiking cycle, which tends to impact the housing market first, then consumer and corporate demand, and then company profits. So the drop-off in company profits – and a spiraling stock market – might be yet to come…

🥡 Takeaways

1. If you’re tempted to pick stocks, give yourself the best chance of success.

Most stocks – from high-growth tech to slow-and-steady utilities – are moving up and down in sync at the moment, which makes picking individual stocks based on their fundamentals tricky. Tricky, but not impossible: the communication services and consumer discretionary sectors have “higher dispersion” than other sectors right now, meaning their fundamentals drive a higher proportion of their stock market returns than companies that are more reliant on wider economic performance (think energy). So if you can identify companies with strong profit growth or cash flow potential in these sectors, you’re more likely to be rewarded for it.

2. But you’re probably better off building a portfolio that’ll hold up no matter what.

A smart tactic for these unpredictable times is to build a portfolio that should hold up no matter what happens next. To do that, start by looking at the sorts of assets that perform well in different economic scenarios: long-term US government bonds in a long and deep recession, gold in a stagflationary environment, and so on. Next, decide your weighting for each asset based on how risky they are. From there, it’s simply a case of regular rebalancing. And sure, this strategy probably won’t shoot the lights out, but it should do well enough over the next five years until we reach a brighter investing climate.

🎯 Also On Our Radar

Coinbase’s stock jumped on Thursday after BlackRock announced it was partnering with the crypto exchange to manage institutions’ bitcoin holdings and trades. It’s another step into digital assets for the world’s biggest investment manager, while Coinbase’s investors – whose shares have fallen 60% this year – will probably be grateful for any boost in revenue it might offer.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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