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Markets and Inflation

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The new year is well underway and we’ve experienced some volatility already in 2022. While the headlines are scary, we have reasons to feel confident about our positioning and investment approach looking forward. Here are a few points:

This market is driven by the Fed. While they are getting more aggressively hawkish, they are not likely to let the markets crash and burn around them. They would really like to do all the things they are promising regarding inflation, but they will almost certainly postpone or reduce the scope of the interest rate increases if the market can’t withstand it (much as was seen in late 2018 to early 2019).

With that said, there is very intense focus on inflation right now. The Fed is in the unenviable position of having to actively fight inflation rather than proactively contain it as they could when inflation was hovering less than 2%. The good news is that there is will across the board to address this. No President since Jimmy Carter has actively asked the Fed to get more aggressive on tightening and inflation fighting- usually, it’s very much the opposite, which makes us feel this inflation fighting is credible. 

Unlike many financial metrics, one of the most important inputs to inflation is what regular people think is going to happen with inflation. The good news is that the one year expectations are around 5%, and the five year expectation is only around 3% annualized inflation. That means consumers think the Fed is credibly going to address inflation in the coming months and years. Inflation is in some ways a state of mind- belief inflation is here can cause inflation, so muted expectations looking forward are a good sign. There are deflationary forces at work in the background, such as slowing birth rates and our relatively high levels of federal debt. Believe it or not, we might find ourselves missing inflation if it’s hard to come by in the future (kind of like Japan).

“The market” is not the S&P 500. TV news keeps putting forth a very dire picture. The S&P was down almost 10% at one point in January, but the fund we have that tracks it is only one of many in Telarray portfolios. At this writing, our large cap value funds, small cap value funds, and all international and emerging positions are performing significantly better than the S&P 500. You might be surprised to learn that, as of this writing, some of our international equity funds are up for the month of January! The continuing outperformance of many of our funds compared to the S&P 500

If we were able to magically close out all positions and completely redesign our portfolios from the ground up with no consequences (tax or otherwise), they would end up looking almost exactly like they do now. We need the bond exposure to provide a buffer and source of cash for rebalancing during equity downturns. Our tilts to small cap, value, and other factors are well positioned for a rising rate/higher inflation market. The international exposure we have is more important than ever as US markets seem poised for some eventual reversion to the mean from the elevated valuations that have developed over the last few years. We have no idea what absolute market returns will be in the coming months and years, but we feel optimistic that, in a relative sense, these portfolios will perform well compared to most other common investing approaches undertaken by do-it-yourselfers or offered by firms like ours. Though seemingly counterintuitive, volatile markets are a great time to sit back and let the power of rebalancing work for you!

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