Market Commentary

A Bear Market in Search of a Recession – What’s in Store for 2023?

A Bear Market in Search of a Recession – What’s in Store for 2023?

I still remember that day – it was sometime in 2007 – I was a young, aspiring private banker in the office of Citibank in Geneva, Switzerland. A dozen or so of us were gathering in Salon Leman on the 6th floor, where some of our best meeting rooms overlooking the lake were located. The topic: capital markets boot camp, a two-day intensive investment training for Citibank staff, led by a senior trader flown in from New York for the occasion.

Despite its name, Salon Leman did not face the lake, it faced the back of the building towards Rue du Rhone, Geneva’s main commercial street. But, from one of the side windows, you could still catch views of the Jet D’eau (Geneva’s iconic water feature) on a clear day. Good for daydreaming…

As it turned out, there would be very little time for daydreaming during our boot camp. Our speaker was witty and engaging, and would proceed to show us the proverbial ropes in a way only a hardened Wall Street veteran could. She had a no-nonsense approach and peppered her presentation with colorful anecdotes about everything from smoke-filled 80s trading floors to investing strategies favored by Japanese housewives.

But out of all topics covered, what stuck with me the most were her comments on bear markets and recessions. What she described was a monetary policy and interest rate pattern that preceded every bear market, without fail, each and every time: “an inverted yield curve,” she said. “And one final rate hike, one rate hike too many…chokes out the economy,” she added, making a strangling motion with her hand around her throat. “The yield curve gets inverted, then the recession hits…”

At that particular time in 2007, the yield curve had been dipping in and out of inversion (inversion simply means that bonds maturing in the short term had higher yields than bonds maturing further into the future, the opposite of what you would normally expect), and the federal reserve had been raising interest rates. Yet there was no talk of recession in the financial media and no signs of economic collapse. “This time is always different,” she told us, the popular explanation for the inverted yield curve at the time was that Chinese buyers had an insatiable appetite for long-dated treasury, keeping long-term interest rates down, and certainly not that we were heading into recession. “There’s always a story,” she said, sarcastically…


Within a few months of our boot camp, the episode now known as the Great Financial Crisis would begin to unfold. A recession so severe that my former employer, one of the largest banks in the world, nearly went bankrupt.

Today, Citibank no longer occupies the lakefront building in Geneva, and my former colleagues have been relocated to a more functional location on the other side of rue du Rhone, minus the lake views.

What, if anything, is a Recession?

I’ve since had plenty of time to reflect on the lessons from that day, and 2022 has offered yet another opportunity to ponder its wisdom. For most of the year, comparing the 2-year yield to the 10-year yield would have shown clear inversion (2-year yields higher than 10-year yields), and the Federal Reserve has been raising rates faster than any time in recent history. With these factors in place, it would seem like stars perfectly aligned for the start of a dreaded recession.

Depending on how one defines recession, it may in fact have already happened. With negative annual growth numbers in Q1 and Q2, 2022 delivered the often cited “two consecutive quarters of negative growth” that constitutes a recession in the mind of many. By that definition, we are either in a recession or just coming out of it.

Indeed, the word “recession” has grabbed headlines all over the world. If Google searches are any indication, it also occupied mind-shares like never before, even more than it did during the 2008 crisis, or the height of COVID lockdowns.

Judging by this apparent recession mania, one might imagine a world engulfed in the depth of a devastating recession. Yet, if this is indeed a recession, it certainly does not feel like one.

The hallmark of a recession, to my mind anyway, involves hardship among the general population, rising poverty, and weakness in the job market in particular.

Yet a photo from the 1930s Great Depression could hardly be more different from what we are seeing today, not only because of how incredibly well-dressed unemployed people were in the 1930s, but also because there simply isn’t any form of employment or income crisis in the US currently.

While some layoffs in grossly overstaffed tech firms have been making headlines, the reality on the ground for most businesses is still that of a labor shortage: a struggle to find enough workers.(1)

While much has been made about declining real (inflation-adjusted) wages, a closer look at income data (Figure 1.C) indicates that keeping up with inflation in this red-hot job market requires one simple step: switching jobs. Indicating that lagging wage growth has had more to do with payroll inertia than anything else.

To be sure, despite strength in the labor market, more bearishly-inclined observers may point to various softer pieces of data, including ISM manufacturing PMI (a survey of 400 industrial companies) which has now declined below 50, indicating anticipated decline in purchasing activity.

Yet once again, growing employment trends appear disconnected from negative survey results, begging the question: if manufacturers anticipate slower activity, why do they keep hiring?

Historically, disconnects between employment data and the more volatile survey results tend to resolve themselves with PMI data catching up to the reality of hiring activity. In other words, watch what companies do, not what they say.

Economic growth returned in Q3 with real GDP increasing by 2.9%, while companies continued to deliver strong results. Whichever way you look at it, the dreaded recession, so far, has failed to materialize. Setting aside news headlines, one might even conclude that as we enter 2023, the US economy isn’t actually slowing, but accelerating.(2)

Never go full Volcker

Much of the continued recession fears boil down to well-founded expectations that the Federal Reserve may hurt the economy with excessive monetary tightening. The pace of rate increases even prompted some observers to suggest that Fed chairman Jerome Powell had “gone full Volcker” a reference to Paul Volcker, the 1980s Fed chairman renowned for bringing rampant 1970s inflation under control.(3) Yet, current monetary policy is a far cry from anything resembling the early 1980s. During Volcker’s tenure, the US experienced the longest period of 5%+ real (inflation-adjusted) interest rates recorded in the post-war era. In contrast, despite all the noise and commotion, the current level of nominal interest rate is still well below inflation levels, and is actually one of the most deeply negative real interest rate environments ever recorded. Against this backdrop, it’s unclear what the current Federal Reserve leadership has done to deserve any comparison with their 80s counterparts. This did not stop public opinion from turning strongly against central bank actions, and a chorus of voices ranging from Elon Musk to the United Nations rang the alarm bell.
As for balance sheet reduction (the other half of the Federal Reserve’s two-headed tightening monster) some perspective is, I feel, also needed. For all the dramatic headlines, it is worth remembering that 2022 is not the first time we’ve seen the Federal Reserve reduce the size of its balance sheet: it had previously declined from about $4.5 trillion in October 2017 to roughly $3.8 trillion in September 2019, before Fed leadership eventually reversed course. Based on today’s balance sheet size, a comparable 15% reduction would require almost $1.3 trillion dollars to roll off the Federal reserve’s balance sheet. Since March this year, the current tightening phase has only resulted in a fraction of that decline (about $0.28 trillion). As things stand currently, the balance sheet remains more than twice as large as it was when the last tightening phase ended in 2019. In a recent report, a team of economists at Wells Fargo estimates the end result of the current tightening phase would involve a $6.5 trillion balance sheet in Q1 2025, a level that would have felt almost inconceivably high in the pre-COVID era.(4) As is the case with the interest rate debate, the mass hysteria over balance sheet reduction seems a bit naive once placed in a broader historical context, or perhaps it is symptomatic of a deeper underlying malaise (more on that later…) At the core, much of the monetary policy debate hinges on your perception of what drives current price pressures. Some believe that inflation is largely driven by temporary disruptions related to post-COVID hangover and the Ukraine war. If that is the case, then current interest levels may indeed already be too high, and the Fed may be committing a policy mistake by raising interest rates in response to transient supply-related factors.
On the other hand, if one believes that demand-related factors (possibly stemming from past monetary excesses) are at the root of current inflationary pressures, one could easily make the case that the current policy stance is still far too dovish and that higher interest rates are needed. Reality is, of course, more nuanced, and both demand and supply factors overlap and interact in unextractable ways. Nonetheless, demand vs supply factors is a piece of data that federal reserve officials have been tracking and are actively aiming to quantify.(5) Interestingly, the Federal Reserve bank of San Francisco’s data in Figure 1.G suggests that, while acknowledging that a lot of inflation remains “ambiguous,” 2022 marked a key cross-over point where demand-related factors have overtaken supply in its impact on inflation. Simply put, prices are rising because people are buying stuff, which is perhaps no surprise when considering the continued strength of the job market and rising wages.

This time won’t be different

Where is the recession then? And what should investors make of the deeply inverted yield curve? And did I, after all these years, forget the lessons of my strikingly prescient 2007 teacher?

The current level of yield curve inversion sends an ominous signal. Not only is it inverted, but the depth and breadth of inversion has reached levels that have always been associated with recession in the past. This time is unlikely to be different.

In 2007, however, it’s worth noting that my boot camp instructor held a deeply contrarian view. At the time, the economy was strong, and analysts were almost unanimously bullish even as markets were making new highs. This could not be more different from the current environment, which is characterized by generalized bearishness among investors large and small. As shown in the left side chart in Figure 1.I, current levels of “net bullishness” (a measure of sentiments among individual investors) is historically associated with very strong equity return in the subsequent year. The chart on the right (Figure 1.I) indicates extreme amounts of negative net positioning (bets that the market will fall) among speculators in the futures market, another strong signal of a possible reversal.(6)

In data going back to 1987, the American Association of Individual Investors has never before recorded 36 consecutive weeks of negative investors sentiments, 2022 is setting a new record.

Bearishness isn’t limited to individual investors either. In a recent Bank of America survey of mutual fund managers, the level of “underweight” equity” sentiment has reached levels consistent with extreme market lows (as happened during COVID and the 2008 crisis):  With extreme bearish positioning and sentiments, it’s worth remembering that predicting a recession and making money from that prediction are two very different things. A quick review of market performances immediately following prior instances of yield curve inversion shows that, on average, stock investors do surprisingly well in the months following inversion.

For what it’s worth, a naive speculative strategy involving a bet against the stock market in July 2022, when the curve first inverted, would have yielded negative returns thus far.

As history has shown repeatedly, investors are prone to herd behaviors both on the upside (buying into a frenzy) and downside (selling into a panic). While the transition away from years of unfettered money supply growth and low-interest rate will almost certainly involve recessionary periods (consistent with the yield curve signal), it’s worth remembering that there is no blueprint, no guidebook, to tell when it will start, how deep it will be, and what path markets might take leading up to it, or coming out of it.

Can we just move on?

While most of this year’s market commentaries have almost uniformly focused on the narrative of an excessively aggressive Fed destroying the economy, I believe a much different reality is taking shape as we enter 2023. In fact, many indicators suggest that the economy has remained stubbornly strong, and while the shift in central bank policy may seem scary, it is really not that dramatic when considered in the broader context. With inflation still running at 7.1%, and the Fed’s predicted “terminal rate” (the peak of its current rate rise plan) estimated at 4.75%, current policies still only make sense under the assumption of normalized inflation levels in the coming months. As for measures of broad money supply, they are still a long way away from what would be considered “normal” by any historical standard, even after recent balance sheet reduction efforts.

On the bright side, there are early signs that some of the high single-digit inflation readings of early 2022 may be starting to cool. However, as we have seen, continued strength in wage and consumer activity means that price pressures are likely to continue. From that perspective, the hope of a pivot in Fed policy may only materialize in the form of a short reprieve.

A strong consensus view has emerged around the idea that the Federal Reserve is aggressively normalizing its policy, that the recession has started, and that the next few months will now simply determine how bad things get (soft vs. hard landing). Reality, in my opinion, is much worse: there is no recession, and the Fed has not normalized its policy.

What makes this state of affairs much worse is that markets must still contend with what comes next. If this isn’t a recession, then what is? If this isn’t a normalized monetary policy, then what will normalization really look like?

Perhaps the obsessively negative mood we currently observe captures more than just recession fear. It captures the hope of a clean transition back to some form of an old normal, a way to move on: one more bout of policy tightening, one more leg down in the market sell-off, an orderly drop in corporate earnings, perhaps a few quarters of negative growth in early 2023, followed by a rebound, and a new upward trend, a sort of economic reset button. To be sure, It may very well happen that way. But as we enter 2023, the economy is still grappling with the consequences of years of monetary and fiscal largess: we’re enjoying its benefits in the form of renewed job market vigor and its increasingly intolerable costs (elevated inflation), as well as distorted markets.

We are still in the midst of the greatest monetary policy experiment of the modern central banking era, and 2022 has, at best, offered hints of what a possible resolution may eventually look like. Hopes of a clean transition out of the current regime, of an economic and monetary reset, are unlikely to materialize. Given the scale of past excesses, investors should brace for the long and winding road ahead toward anything resembling “normalization.” In all likelihood, it will involve repeated see-sawing between varying degrees of monetary tightening and loosening, and a heavy dose of fiscal policy attempting to even the playing field. From that point of view, 2023 may only mark the beginning of the process. And as much as we’d like to, we can’t just move on.


Headshot of financial advisor Syl Michelin in a blue suit with white button up shirt and gray background

Syl Michelin, CFA


Syl Michelin is a Chartered Financial Analyst and fee-only, fiduciary financial advisor who works with cross-border families and American expatriates.

3 Reasons to Look at Investing Internationally in 2022

3 Reasons to Look at Investing Internationally in 2022

In 2021, the U.S. stock markets hit record highs almost 70 times, and the consensus is that the U.S. market is largely “expensive.” Such a snap view is confirmed by a variety of valuation metrics: price-to-earnings ratios (P/E) and forward P/E being chief among them. Moreover, the bond market is poised to face a rough 2022 because there is a growing consensus that the United States Federal Reserve Board (also known as the “Fed”) will also increase interest rates, which historically has caused bond prices to fall. Between this seeming domestic “rock and a hard place,” there are some areas that continue to look like good deals: one of which is international equities.

In this article, I will cite three key reasons why investing now in international markets might be a good long-term investment: or, in other words, explain why the U.S. is expensive and the rest of the world is not.

Currency and the Almighty Dollar

The U.S. dollar is relatively strong right now – and indeed might get stronger in the near future because the U.S. may raise interest rates as soon as March. Indeed, the dollar posted its best year since 2015 in 2021, and the U.S. dollar index (DXY) was up 6.5% in 2021

However, overall a stronger U.S. dollar will make international goods and services more competitive (or allow manufacturers to make more money) in the longer run. How does that work? In short, a stronger U.S. dollar means it is less expensive to buy foreign goods and services. If the dollar is weak versus the euro (let’s say $1 equals 0.8€), for example, a purchase of an automobile that costs 30,000€ would equal $36,000, and the automobile will be compared to those similarly costing $36,000. If, however, the dollar is strong (let’s say $1 equals 0.9€) a 30,000€ automobile would only cost $33,000. A manufacturer can deal with this in a variety of ways– it can aim to sell more cars at less price (instead of 10,000 cars at $36,000 try to sell 15,000 at $33,000) or the same number of cars at the original $36,000 price, booking the currency gain of $3,000. In either case, the firm will be helped by the stronger U.S. dollar.

The U.S. dollar being strong also has the effect of meaning that just as the foreign currency could theoretically buy more car for less– a stock originally priced in euro can also be bought for less. Indeed, foreign market returns for U.S. investors were hindered by approximately 5.2% by currency headwinds last year due to the strengthening U.S. dollar according to JP Morgan.

An additional tailwind of a strong dollar for international markets is that it frequently promotes international travel, improving many economies that depend on tourism for a large chunk of their GDP. However, the ongoing pandemic may lead to this effect being muted. Should COVID progress to an “endemic” rather than a pandemic, we’ll likely see an increase in travel to foreign countries buoyed by pent-up demand for travel and the ability to buy more with less.

(For those who prefer a video explainer from the perspective of U.S. companies, look here for an overview from the WSJ)

Rest of the world GDP growth 

One of the ongoing beliefs is that the U.S. economy (and accordingly its stock market) is doing better because the U.S. economy is doing better than the rest of the world. This is not necessarily the case.

In fact, between 2012 and 2019 the GDP growth rate of the rest of the world surpassed that of the United States by 0.5% per year – though this was admittedly a cooling down as the rest of the world grew at a rate exceeding the U.S. by 1.2% from 2001-2011 according to the JP Morgan Guide to the Markets. In fact, the last time the U.S. outpaced the rest of the world in GDP growth was from 1992 until 2000. Despite this growth advantage, U.S. large-cap stocks have outpaced the rest of the world (the MSCI EAFE index) by roughly 275% over the last 14 years. (JPM)


This might be the most compelling case for looking at non-U.S. equities going forward – an international note we’ve hit on in our Gimme Some Truth podcast before in this episode. As I noted in the introduction, the U.S. (particularly U.S. large-cap stocks) is trading very high relative to its longer-term P/E measures. There are several reasons for this, but a key one is the low-interest rates in the United States and a very strong run for U.S. technology over the last 10 years. On the other hand, despite negative interest rates, valuations of non-U.S. stocks have not soared. 

Indeed, relatively speaking, valuations for non-U.S. stocks are deeply discounted compared to the U.S. Again, according to the JP Morgan Guide to the Markets, the rest of the world’s forward price-to-earnings ratio (FPE) was at 14.1 versus the S&P 500’s 21.2 FPE. This is compared to a 20-year average of 13.3 FPE versus 15.5 FPE for the U.S. In other words, the rest of the world is trading at a 32.7% discount versus U.S. FPE, which is significantly off of its 20-year discount of 13.2% discount. Moreover, the rest of the world is yielding higher than the U.S. right now. On average, the U.S. has dividend yields about 1.6% less than the rest of the world (compared with a 1.1% average difference over the past 20 years).

Such data also apply as we look from region to region. For instance, Japan, despite macroeconomic forecasts of 3.2% growth next year, is currently trading below its 25-year forward P/E ratio. 

In short, even if we take into account that the rest of the world tends to trade at lower valuations historically, the rest of the world is trading at a discount in terms of price to earnings. 

There is an old saying in investing that the market can stay wrong longer than you can stay solvent. While we don’t go that far in our risk-taking, the 14-year ongoing out-performance of U.S. large caps has exceeded the longest previous period of out-performance by approximately 6.5 years and growing (the rest of the world outperformed the U.S. for 7.3 years from approximately 2001-2008; the longest period of U.S. out-performance was a little over six years during the 1990’s dot com boom). It is impossible to predict when the shift will occur, but from a long-term perspective, the rest of the world is looking like a better and better deal.

Keith Poniewaz, Ph.D.

The Year of Impossible Choices: 2022 Market Outlook and 2021 Review

The Year of Impossible Choices: 2022 Market Outlook and 2021 Review

In last year’s market outlook, I described the current state of global monetary policy as a giant exercise in price control, specifically, control of the cost of capital. An environment in which perpetually falling rates and equity premiums favor longer duration growth stocks, but hardly resulted in what might be described as widespread prosperity. 

The (short-lived) revenge of the bottom half

During the grand re-opening of 2021, for a brief moment, dare I say it, things seemed to be going well. Bolstered by massive government stimulus and a strong job market, something remarkable happened to the average American household: they got richer.

While household wealth rising is not surprising given equity, real estate, and cryptocurrency gains, what was truly remarkable was the relative gain attributable to the bottom 50% of American households, whose share of total wealth rose above 2.5% in Q3. While the percentage remains low in absolute terms, we had not seen this metric rise above 2% since the 2008 crisis, and 2.5% was last witnessed in the early 2000s.

A tight labor market, marked by the “great resignation” (an unusual number of people quitting their jobs), has certainly contributed to the slight, but noticeable, narrowing of inequalities. For the first time in years, the labor market appears to have shifted in favor of workers, who may be in a much stronger position to secure higher wages, strengthening their ability to accumulate wealth. Direct COVID relief payments and expended child credits also contributed to this continued improvement in household wealth.

Unfortunately, before anyone could celebrate a resurgence of the American middle class, a much bigger story would steal the headline: the return of inflation. In the short term, moderate levels of inflation can have a beneficial effect on the job market, support asset prices, ease debt burden, and even reduce income inequality. In the long term, however, the upside risk to inflation makes me less than enthusiastic about the potential for a continued trend in narrowing wealth inequalities. 

While higher inflation means that everyone, in aggregate, gets poorer, some might get hurt more than others. Over time, cost pressures are likely to favor owners of productive assets at the expense of small savers and wage earners. A recent analysis by the Penn Wharton Budget Model already highlights the increasing burden on middle-income family budgets, who spent about 7% more in 2021 for the same products they bought in 2020 or in 2019. (3)

The era of low inflation never started, now it may be ending

The return of higher inflation, in the form of her CPI numbers, was heralded as a momentous shift in the economic environment in 2021. After all, inflation has not been a major concern in most of the developed world in the last decade, some have even suggested that we lived in the era of low inflation, and central bank action certainly focused on fighting the perceived threat of deflation first and foremost.

I was never a huge believer in the idea of a “low-inflation era.” To be sure, we may have had moderate levels of inflation on average, but more importantly, we’ve had an era of uneven, patchy inflation, where falling prices in some areas were offset but rapid increases in others. 

What charts like the one above highlight, is that the supposed low-inflation era has, in fact, been an era of selective inflation. An era in which, broadly speaking, the price of things we don’t really need, like toys and electronics, has collapsed, but the price of things we need (say, food, housing, and healthcare…) has continued to rise. 

In this environment, it is perhaps no surprise that middle-class households hardly seemed to reap the benefits of low prices. All else being equal, and despite the prevailing inflationist narrative: no inflation is good, deflation is even better (how often have you complained about prices at the store being too low?). For two decades deflation has been limited to a relatively small segment of largely discretionary expenses, while higher costs in other products may have actually reinforced inequalities. 

Regardless of how the Consumer Price Index is composed, it is also important to recognize the limitation of the CPI (our policy makers’ main tool in measuring inflation). CPI is a complex set of data maintained by the Bureau of Labor Statistics. Over the years, its methodology has been revised multiple times, and most recent adjustments have tended, in my opinion, to make monetary policy look better. Some of the most convenient CPI adjustments include: substitutions (the idea that if something is too expensive, we’ll just buy something else, say lemons instead of bananas…) or, even better: hedonics (an adjustment made when a price increase isn’t actually deemed to be a price increase, but just a reflection of improved product features). Not to mention the fact that shelter, one of the largest components of CPI, is for the most part not collected using a market-based mechanism. Instead, most of the CPI’s shelter data comes from something called Owner Equivalent Rent (OER). OER is basically a survey of homeowners, who get asked a simple question about how much they think their property could be rented for (imagine calling your parents who’ve lived in their house since 1976, and asking them what they think the rent is). 

Regardless of how much I doubt inflation numbers, what became obvious in 2021 is that no amount of adjustments could make inflation look benign. Since March 2021, CPI inflation started exceeding the Federal Reserve’s 2% target and has continued to rise ever since.

In August 2020, the Federal Reserve implemented a new flexible approach to inflation, effectively warning the market that it may allow inflation to “run hot” for a while if it deemed necessary. We are now in our ninth month of excess inflation, and just how much more of these inflation numbers will be tolerated is unclear. 

Over the last few years, central bank officials have often felt the subtle (or not so subtle) pressure to keep their policy stance accommodative (remember Donald Trump praising Janet Yellen for being a “low-interest person?). But politicians and the general public can be fickle, and the pressure to remain accommodative can just as easily morph into a pressure to tighten. If inflation continues to take hold, being a low-interest rate kind of person may not look so flattering anymore.

The trillion-dollar checking account

I have long been telling clients that the pandemic could, somewhat counterintuitively, be the catalyst for higher inflation. By pushing governments and central banks to implement a combination of both extremely loose monetary and fiscal policy, they may just have poured fuel on a fire that had been simmering for years underneath the low CPI numbers. While 2020 saw unprecedented levels of new debt issuance and stimulus, a lot of promises only reached full implementation in 2021, which may explain the sudden, but somewhat delayed, change in inflation dynamics. 

The U.S. Department of Treasury’s general account with the Federal Reserve (effectively, the government’s checking account) spent most of 2020 swelling up to unprecedented levels: normally fairly steady at a balance of around $300 billion, it reached a balance of $1.8 trillion in mid-2020 at the height of the pandemic.

In contrast, 2021 was truly the year of the great spending spree, when checks were finally cashed, even as treasury bill issuance slowed. $1.6 trillion was promptly spent in a matter of months between February and July 2021. As Citi’s market strategist Matt King highlighted back in February 2021: the flood of cash created by the drawdown in the treasury’s general account (TGA) risked tripling the amount of bank reserves, and pushing rates even further towards zero or negative territory: “surfeit of liquidity and a lack of places to put it – hence the rally in short-rates to almost zero, with the risk of their going negative.” As King further notes, “if relative ‘real’, inflation-adjusted Treasury yields fall, it could weaken the dollar sharply (…) at the global level the TGA effect will indeed prove highly significant.
As shown above, real yield would indeed fall throughout 2021, to levels unprecedented in modern history, and one of the side effects of negative real yield may have been to propel the now-familiar “risk on” investment theme to new heights. We all thought money was cheap at -1% real rates in February, how about -6.5% In November? 

The treasury department wasn’t the only one spending. As it turns out, American households too were fast and loose with their checkbooks. Individual savings rates had risen during the pandemic and remained relatively elevated well into the beginning of 2021. Since March 2021 however, saving rates have fallen back to their pre-COVID levels.

Against this backdrop, it is perhaps no surprise that the “buy everything” ethos, long limited only to financial assets, now seems to have spread into housing, commodities, energy, various consumption goods, and even used cars.
With gains of nearly 50% since December 2020, the Manheim Used Vehicle index outperformed both the S&P 500 and the Dow Jones in 2021.

Impossible choices

Over the last decade, central bankers have been almost entirely focused on supporting the economy. With the threat of inflation only a distant concern, there has been basically no downside to perpetually flooding markets with free money. To be sure, central bankers have been fairly successful in averting deflationary fears and consistently driving down real (inflation-adjusted) rates. With short-term rates at zero and longer-dated bonds at historic lows, many observers felt that yields had nowhere else to go. Real, inflation-adjusted rates have no such lower bound. And as much of what the recent spike in inflation will be heralded as a change of regime, in many ways, it can also be seen as the culmination of a broader trend in lower real rates that started many years ago – and arguably as far back as the mid-80s.

With real yield deeply negative, and central bank balance sheets at all-time highs, 2021 brought the scale of global monetary policy to yet another record-breaking year. However, for the first time in over a decade, inflation may truly force central banking officials to tighten policy this time. So far, policy response in the U.S. has been mainly limited to tougher talk and a planned reduction of the pace of asset purchases (the now-famous “tapering”). While FOMC guidance does indicate an expectation of multiple rate hikes in 2022, the Federal Reserve will be walking a very fine line as it looks to change course.

One of the paradoxes of the current environment is the continued flattening of the yield curve. A flood of bank liquidity may have contributed to the collapse in real short-term rates but has not resulted in any real upward shift in long-dated bond yields. This could be interpreted in numerous ways. Perhaps the bond market is simply not buying the idea of long-term inflation or may think it raises the probability of a policy mistake (excessive tightening leading to a deflationary crisis), or perhaps the Federal Reserve’s bond-buying program has simply distorted bond prices to such a degree that rates no longer reflect any realistic growth and inflation expectations. Whatever the case may be, hiking rates in this environment would mean running the risk of yield curve inversion: a situation where short-term rates would exceed long-term rates. While not always predictive of a crisis, an inverted yield curve generally sends a very negative signal and isn’t consistent with a healthy economy, in which opportunity cost should correlate positively with time.

Central banking officials are very aware of the risk, and the issue of curve flatness was explicitly brought up by members of the FOMC in their December meeting. There is a certain common-sense logic to the idea that, before resorting to traditional monetary tightening policies (raising short-term rates) the Federal Reserve should first get rid of the more exotic, experimental, crisis-time measures, such as quantitative easing. Doing so may allow long-term interest rates to rise, resulting in a more constructive environment in which to hike short-term rates. After all, if the economy is strong, to the point of raising rates, why have QE at all? That does not seem to be what committee members are thinking. In fact, according to their latest minutes, they seem intent on doing the exact opposite: begin to raise rates as early as March 2022, and then tackle balance sheet reduction. Even so, balance sheet reduction would not resemble a complete termination of their bond-buying program, but would probably involve a monthly cap on the amounts of “runoffs” (treasury bonds allowed to mature without being reinvested). Assuming that the monthly cap on runoffs does not exceed monthly maturities, the net effect of this policy may be that the Federal Reserve will be continuing to buy billions of dollars worth of bonds every month for the foreseeable future. Presumably with the hope that slowing the pace of balance sheet reduction will act as a buffer against the possible negative effects of rate hikes. 

In this balancing act between tapering and rate hikes, one might perhaps perceive a subtle acknowledgment that central bank officials have made themselves into de-facto custodians of stock prices. After all, their previous attempts at an interest rate hike cycle in 2018 ended in a 20% market sell-off and had to be promptly reversed. At today’s valuations, a similar sell-off would wipe out nearly 10 trillion dollars of value from the S&P 500 alone. Ultimately, the message buried in the complex mix of central banking rhetoric may simply be that the Federal Reserve intends to stay behind the curve in its attempts to tackle inflation. That it intends to tighten policy slowly, while remaining accommodative and relying on the magic of negative real rates to support asset prices and the economy, tightening without tightening. Exactly how long they can get away with this in the face of higher inflation is anyone’s guess. Given the huge political stakes around issues of wealth inequalities, and with midterm elections around the corner, I expect pressure on the Federal Reserve to ramp up over the coming months. Backed into a corner, central banking officials may just have to pick between continuing to support market valuations and curbing cost pressures. However things turn out, 2022 may very well be the year when investors and US households alike realize that free money does have a cost after all.


Syl Michelin, CFA

2022 Investment & Market Outlook Guide

Syl Michelin’s piece is part of Walkner Condon’s 2022 Investment & Market Outlook Guide, a comprehensive reflection of 2021 and glimpse at the factors impacting the year ahead in 2022.

2022 Investment and Market Outlook Guide

2022 Investment and Market Outlook Guide

Walkner Condon’s team of experienced financial advisors explores key topics that are top-of-mind as we transition out of 2021 and into a new calendar year, featuring the market outlook and review from Syl Michelin, a Chartered Financial Analyst™. Other topics include index funds, sector & factor performance, a pair of U.S. expat-focused pieces, and more.

Below you can find a breakdown of the individual pieces in this year’s outlook. 

1. The Year of Impossible Choices: 2021 Market Recap & 2022 Outlook
Syl Michelin, Chartered Financial Analyst™

Through a lens of current and historical data, Walkner Condon’s resident CFA® – and one of our U.S. expat advisors – explores the last year in the markets, with an eye on factors that may impact 2022. 

2. It Only Gets Harder from Here: Valuations, Bond Environment & Wage Growth
Clint Walkner

With a multitude of market highs throughout 2021 and a long stretch of gains post-2008 financial crisis, it would appear the “easy” money, if we can call it that, has been made. In this piece, Clint dives into the three main challenges as we move forward into 2022.

3. Reviewing 2021 Sector and Factor Performance and Positioning in 2022
Mitch DeWitt, CFP®, MBA

The markets were up routinely throughout 2021, but that doesn’t mean the gains were shared equally. Mitch discusses the sector winners (and losers) of the last year, along with what factors – things like high beta, value, and quality – had their day in the sun. He also goes into what might be on the horizon this year.  

4. Exploring Index Funds: History, Construction, Weightings & Factors
Nate Condon

The goal of this piece from Nate is to provide a general overview of indexes, the differences in how indexes are constructed, including equal-weighted indexes versus market capitalization-weighted indexes, and passive and factor indexing strategies.

5. Three Reasons to Look at Investing Internationally in 2022
Keith Poniewaz, Ph.D.

Though the U.S. dollar had its best year since 2015 in 2021, Keith – another of our expat advisors – explains several reasons to think about international investments in 2022, including the very strength of that U.S. dollar, valuations, and the rest of the world’s growth in GDP.  

6. Top Five International Destinations for U.S. Expats in 2022
Stan Farmer, CFP®, J.D.

One of our U.S. expat experts, Stan jumps headfirst into possible locations for Americans to consider in 2022 if they’re thinking about a move abroad – or even if they’re just wanting to dream a little bit. Stan covers ground in South America, Europe, and Asia in this thorough piece, perhaps his first crack at being a travel journalist in his spare time.

WEBINAR: Global Markets and Investing Outlook for 2022

WEBINAR: Global Markets and Investing Outlook for 2022

While U.S. markets have outperformed international markets for more than 10 years, non-U.S. equities still have their place in a diversified portfolio, as we’ve previously discussed in an episode of Gimme Some Truth.

So as we turn the page to 2022, we wanted to examine the international picture and outlook ahead for U.S. expats. Walkner Condon’s team of U.S. expat advisors welcomed Gregg Guerin, a London-based Senior Product Specialist from the First Trust Global Portfolios team, to dive into the Global Financial Markets.

You can catch the full replay of the webinar below or by visiting Walkner Condon Financial Advisors’ YouTube channel.

If you have any questions from the webinar, feel free to use the button below to let us know.
Walkner Condon Financial Advisors is a registered investment advisor with the SEC and the opinions expressed by Walkner Condon Financial Advisors and its advisors in this webinar are their own. Registration with the SEC does not imply a certain level of skill or training. All statements and opinions expressed are based upon information considered reliable although it should not be relied upon as such. Any statements or opinions are subject to change without notice. Information presented in this webinar is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Information in this webinar does not take into account your specific situation or objectives and is not intended as recommendations appropriate for any individual. Viewers are encouraged to seek advice from a qualified tax, legal, or investment advisor to determine whether any information presented may be suitable for their specific situation. Past performance is not indicative of future performance.