Markets were off to a roaring start for the first month of the year as both bonds and stocks rallied. The assumption that inflation was in check and that aggressive Fed tightening would soon come to an end fueled the move. Of recent, that theme proved incorrect with PPI coming in stronger than expected along with other indicators. The battle this year will be between Fed policy and market appreciation. Any significant rise in asset prices elongates the Fed’s inflation battle and they will jawbone markets sideways or downward until PCE is subdued. Higher short-term rates for a longer period should be expected, which has major implications for investments.
Despite the market’s challenges of 2022, higher rates make investing much more efficient. Risk-free money now yields four percent, which becomes the minimum required rate of return (RRR) for every investment decision. That means executives must run their business with the goal of producing net income north of four percent over the long run to warrant investor attention. For the last 15 years profitability was an afterthought for most executives as top line garnered all the attention. That dynamic has changed and is here to stay. Quarterlies are flowing and managements that are focused on the bottom line are being rewarded by stock appreciation, as noted by tickers like BX, RACE, PLTR, and PANW. This new RRR is also shaking the foundation of other markets like real estate and private equity and those prices will need to adjust. Assets that yield more than risk-free money will attract investors over the coming quarters and we are allocated to such.
As always, I appreciate your continued trust and confidence.