Back in August 2018, Fortune magazine ran a cover story that received a lot of attention at the time.
Titled “The End Is Near,” the feature column laid out a base case for the next recession that, while making perfectly good sense, didn’t pan out as predicted, at least not yet. The article claimed in bold red print that the economy will slow, and the bull market will expire.
Three and a half years later, the economy remains on good footing, but there are emerging caution signs that investors should not be complacent. Hence, if the risk of a slowing economy is in the offing, then some portfolio rebalancing is probably in order to stay invested while dialing back the exposure to elevated volatility.
The forces that would cause the economy to stall have been extended out because of quantitative easing (QE) and Congressional stimulus in the trillions of dollars. The global economy ran aground with the onset of COVID-19, upending what would be the normal course of the business cycle where economic activity reaches a peak, then begins to contract until eventually it bottoms and then starts to grow again.
We are now in the fluid period where the huge infection rate of the Omicron variant of COVID-19 continues to impact the supply of laborers who are calling in sick or not returning to the workforce. This condition of widespread worker disruption and the ongoing stringent and time-consuming COVID-19 protocols only produce additional shortages, resulting in a potential increase in inflation over the near-term.
This week’s FOMC meeting has the market bracing for whether the Fed will lay out an even more aggressive policy than what surfaced in December. Demand for goods and services is very strong, keeping prices elevated. Some might think this is a nice problem to have, considering the alternative. And assuming Omicron does burn out around the globe over the next two to three months, it is thought that a good deal of the inflationary pressures will start to ebb and gradually decline from the current 7% annual rate to around 3% by the year’s end.
Because inflation is so stubborn, growth estimates are coming down. The Conference Board forecasts that “U.S. real gross domestic product (GDP) growth will rise to a 6.0% annualized rate in Q4 2021, vs. 2.3% growth in Q3 2021, and that 2021 annual growth will come in at 5.6% year over year). Looking further ahead, we forecast that the U.S. economy will grow by 3.5% year over year in 2022 and 2.9% year over year in 2023. This forecast incorporates a slight downgrade for Q4 2021, but no material change for economic growth in 2022.” (Source: https://www.conference-board.org/us/)
The shrinking labor pool keeps upward pressure on wages that in turn hits corporate earnings directly, as does the rising cost of inputs to make things. Commodity prices are up across the spectrum, all trading at or near their multi-year highs, crude oil being the largest contributor to commodity inflation. Ultimately, corporations and organizations will have a harder time passing on these higher costs to buyers, creating demand destruction that leads to slower growth. And it’s fair to say the economy is entering that phase of the business cycle.
With the Fed talking tough on ending QE, raising rates and reducing the size of its $9 trillion balance sheet, the value of the dollar will likely stay at its current level, or even trade higher against other currencies. A strengthening dollar makes oil more costly for other countries, thereby tempering global growth.
Seeing WTI crude top $100/bbl. adds to the to the slow growth narrative that is already impacting China. On Jan. 12, Goldman Sachs cut its 2022 GDP forecast for China to 4.3%, a big reduction from 2021 with GDP running at 8.1%. Last week, the CCP announced a crackdown on business corruption and a zero tolerance COVID-19 policy.
Growth rate of real gross domestic product (GDP) in China from 2011 to 2021 with forecasts until 2026
According to the U.S. Energy Information Administration (EIA), 67.3% of China’s crude oil supply in 2019 came from imports. This dependence on foreign energy is likely to increase. Some estimates have suggested that by 2040 around 80% of China’s oil needs will be sourced from elsewhere. And this assumption accounts for all the advancements in renewable energy and the advent of electric vehicles.
If in fact, investors are facing a market of slower growth prospects, then stock picking is at a serious premium where rebalancing portfolios to include more ballast dividend and dividend growth stocks should be considered to compliment growth stock holdings. In the past week, energy, consumer staples, utilities and telecoms have far outperformed all other market sectors with many stocks paying dividend yields of 3-5%.
Rotating capital into stocks of companies with a history of increasing dividends by double-digits on a yearly basis is a viable course of action if portfolios are overly weighted in pure growth. It’s clearly what the market is favoring under the current investing landscape and is worth noting, especially for those investors that are retired or nearing retirement.
The market is extremely oversold and due for an earnings season-related bounce over the next month, which will provide a great opportunity to reposition and reduce portfolio beta. There is a time and place for increasing portfolio weightings in dividend growth and ballast dividend stocks. Until the Fed is done doing what they are going to do, it would seem then that there is no better time than the present to take appropriate action.