Inflation Will Cool, but Only Briefly. What to Expect.

We are currently near the top of those two steps. The pandemic ushered in a major reallocation of spending from services to goods. U.S. inflation should dip over the next six to nine months as the demand for goods decelerates and supply-chain disruptions abate.

The respite from inflation will not last long, however. The labor market is heating up. So far, most of the wage growth has been at the bottom end of the income distribution. Wage growth will broaden over the course of 2022, setting the scene for a price-wage spiral in 2023.

We doubt that either fiscal or monetary policy will tighten fast enough to prevent such a spiral from emerging. As a result, U.S. inflation will surprise meaningfully on the upside.

—Peter Berezin

Troubling Change in China

Cumberland Advisors Market Commentary
Cumberland Advisors
Nov. 19: In the new China finance regime, a required personal contribution to resolve a debt problem is now a standard. That new standard is there, whether it was originally agreed to or not. Here’s the proof [from caixinglobal.com]: “Evergrande Chief Borrows $105 Million Against Hong Kong Properties.”

Where this leads, no one knows. But it is regime change, now applied in the world’s second-largest economy. And it is applied retroactively to the major players, who will comply because they fear for their safety (maybe their lives?). In the world of finance, a retroactively enforced personal guarantee is a new thing to contend with. It is like playing checkers with its “have to jump” rule and finding the rule changed in the middle of the game.

That means the terms of borrowing and use of debt and leverage are profoundly changed, as well. So is the credit analysis of debt. Maybe China will be better in the long run for initiating such discipline, but right now, it is administering a shock. We expect more difficulty within the Chinese capital markets and with those firms that used the U.S. financial markets as their sources of capital. We’re underweight China in our International Equity ETF portfolio. We continue to be cautious about investment there.

—David Kotok

Why Powell Is the Logical Pick

Washington Policy Weekly Update
BTIG
Nov. 19: We still believe the odds slightly favor Federal Reserve Chairman Jerome Powell being renominated for another term, although we fully admit that Fed Governor Lael Brainard’s prospects appear to have improved, both among our contacts and in prediction markets. In our view, renominating Powell is a logical step for the following reasons:

• Although Powell and Brainard would almost surely both secure Senate confirmation, Powell would cruise through the process and secure bipartisan support.
• Progressive opposition to Powell has been relatively modest and disjointed.
• Powell’s renomination could provide a modicum of political cover to advance the nominations of more progressive board and vice chair nominees.
• Even though Powell and Brainard appear to have similar monetary-policy views, our sense is that the markets would welcome the leadership continuity that comes with a second term for Powell.

One of the lines you hear most often in Washington is “personnel is policy.” This maxim is true across government, but especially so with the Federal Reserve, given its centrality in the global economy. In this vein, we firmly believe that the White House will use its remaining nomination opportunities to advance progressive picks who will prioritize full employment. In discussing the open Federal Reserve Board seats, we have heard the following names mentioned: CEA Chair Cecilia Rouse, AFL-CIO Chief Economist William Spriggs, professor Lisa Cook, and economist Seth Carpenter. In recent days, Roger Ferguson’s name has resurfaced, as well.

—Isaac Boltansky

Growth Trumps Value

House Views
Truist Advisory Services
Nov. 16: Consistent with our sector strategy, where we upgraded the technology sector, the largest sector in the growth style, we are upgrading our view of the growth style, relative to value, to Neutral from Less Attractive.

Technology has been much stronger in our quantitative work, and its price relative to the broader market recently broke out of the trading range it has been in since September 2020. The consumer-discretionary sector, which is the second-largest in the growth index, is also showing strength in our work.

While we still have a favorable view of the cyclical sectors, such as financials and energy, the S&P 500 Value Index, our primary value benchmark, has a heavier weighting to defensive sectors, such as consumer staples and utilities, which are making new price lows, relative to the market and where we are Underweight in our sector strategy.

As a result, the value index doesn’t fully reflect the cyclicality that we favor, given our view that the third-quarter growth scare is in the rearview mirror and that the U.S. economy is set up for positive surprises. This is also another reason we prefer U.S. small-caps, which have more exposure to cyclicality and less exposure to the defensive sectors.

—Keith Lerner

Favoring Fixed Income

Weekly Market Commentary
Winthrop Capital Management
Nov. 15: Interest rates continue to creep higher, and spreads on riskier assets remain tight. Interest rates have increased over 60 basis points, measured by the yield on the 10-year U.S. Treasury, since the beginning of the year. This has put pressure on performance across most fixed-income asset classes, as the total return for the Bloomberg U.S. Aggregate Index is down 1.80% year to date.

In addition, investment-grade credit spreads are tighter by 10 basis points, year to date. With credit spreads trading at historically tight levels, the real yields on interest rates adjusted for inflation are negative. We expect this phenomenon to persist through next year as the rate of inflation remains elevated.

Considering these challenges, the fixed-income asset class still plays a critical role in a diversified portfolio asset allocation. Over a 30-year cycle, fixed income has consistently proved to be the best way to diversify a portfolio and manage performance through capital-market volatility. Both long-term and near-term correlations across equity and fixed-income markets have remained negative. With equity-market valuations at historically high levels, our assumption for expected returns is significantly lower, and portfolio diversification is extremely important.

We are in the process of reducing the large-cap growth allocation in portfolios and adding value-based strategies. In addition, we are utilizing short-duration fixed-income strategies in our asset allocation in order to further protect our portfolios from interest-rate volatility. While expected returns may be lower, these fixed-income strategies should protect principal and provide better protection against rising inflation than broad market strategies over the intermediate term.

—Gregory J. Hahn, Adam Coons

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