The risk of this happening has risen especially in Europe, where on top of the pandemic-induced supply shock comes a supply shock caused its dependency on Russian energy. Stagflation describes the scenario where high inflation meets a stagnating economy. As KKR puts it in their mid-year update: “it could have actually been worse, if productivity had not been booming.” So far, the heightened inflation was accompanied by relatively high productivity and slight growth.
The only problem: timing the market is hard. As soon the market is recovering, rebalancing towards non-dividend paying low price-to-book value stocks promises handsome returns later on. However, the best way seems to be to hold cash until the bottom of the market has been reached. Especially during the current period of high inflation, this seems to be an interesting way to hedge against an approaching recession. In the past active value investors in the United States were able to reduce their losses during a recession and outperform the market by holding significantly dividend paying value stocks and simultaneously re-investing the dividends.
One way for value investors to prepare for an approaching correction is to follow the general advice derived from the study: hold cash or at least rebalance towards a conservative value stock portfolio. As it is hard to predict when the recession really hits rock bottom, there is no easy strategy for investors to hedge against it. The most difficult task for investors is to time the market – especially during inflationary periods. The question is: can the FED and the ECB, in such a challenging macroeconomic environment, cool down inflation without disrupting the labor- or housing market? Or will they instead – accidentally or on purpose – trigger a recession, as it was the case in the 1970s? Now see a situation where low unemployment meets record high inflation which central banks already try to tackle with an aggressive tightening policy which poses a heightened risk of policy error. Over the past two years, the economy has been rescued with massive quantitative easing. Presently, we are experiencing an unprecedented situation. The unprecedented situation also brings certain risks investors have to be aware of, especially: This kind of active engagement in the economy was previously unknown to investors.īesides more stimulus than ever before, we are also experiencing supply side constraints and heightened geopolitical risks – which are here to stay for the foreseeable future. In 2020 more than 3.5x the amount of the 2008 stimulus was spent to rescue the economy. Especially in the U.S., cash was handed out directly to consumers, totaling > $1.5 trillion in stimulus payments, unemployment insurance, and tax credits. While in 2008, politicians and central bankers stimulated the economy with very little direct cash injections into the average consumer wallet, in 2020 the approach was entirely different.įor the last two years, the financial system has been overstimulated with a massive amount of quantitative easing. Instead, we must adapt.Īs I have looked in my study at the returns of value stocks during the global financial crisis 2007-2008 and the European debt crisis, it is important to note how remarkably different governments and central banks have responded in 2020 and beyond. This makes it dangerous to simply do what worked previously. These structural forces have not been seen in this combination before. What makes 2022 so different from previous market cycles and recessions?Īs of mid-2022, we can simultaneously see: It is necessary to be aware of these forces to utilize a different approach when it comes to constructing our portfolios in 2022 and beyond. The “Great Reset”, the COVID-19 pandemic and the subsequent Russia Ukraine invasion initiated a new era of geopolitics and thereby a new economic landscape.
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