OK, so Q1 of 2024 is all wrapped up. And still no sign of recession. Or any rate cuts just yet now that I’m thinking of it. Hang on a sec? Weren’t they meant to have happened by now or at least be pencilled in the diary? The Fed is keeping schtum on that front and not letting any cats out of any bag. And with the blowout jobs report going above all expectations, it kinda puts them in a really sticky situ. 

Their literal job is to ensure stable prices with a target of ~2% inflation. Anything above or below that is a fail. Sure they’re gonna wanna balance that with other big things in like moderate rates and low unemployment but inflation is their #1 priority (or it at least should be).

See, inflation is a tax on your (already-taxed) earnings. It slowly but surely erodes your purchasing power without you lifting a finger. And actually, thanks to your money now being able to buy less than it once could, you’re gonna have work more to keep up with the pace of price rises that might seem otherwise invisible. 

Soft landing – what is it anyway? It’s when the Fed can cool inflation (so bring it back to their target of 2%) without causing a sharp increase in job losses (aka a spike in unemployment). It’s like walking a tightrope. With the entire world banking on the outcome. Literally. 

Right now, with interest rates where they’re at, the Fed is paying through their nose on interest costs on their (sky-high) debt. Last year alone, the Fed shelled out $658bn on net interest costs on their national debt which btw grew by 38% from 2022. So you can see how ‘higher-for-longer’ ain’t good for the Fed. It’s costing them too much. So will they cut rates (bring down their own borrowing costs) and abandon their fight on inflation? Ditch their attempt at bringing prices down and kinda let things float along? 

Given this month’s jobs report it shows that rates will not be cut nearly as much or as fast as we’re all hoping for them to be since the economy is just too hot. Like your porridge. It needs to cool down. And for that to happen interest rates will need to stay higher, and for longer. Till the job is sorted. 

But that means borrowing costs will continue to rise. And not just for the Fed. For all of us. As I like to say, no one really knows what the future holds and betting against the Fed is never a wise move but we don’t know what’s coming. For now, signs point to “too-hot”. But a slowdown could be on the cards by which point rate cuts might be on the table. For now, I don’t really see rate cuts in sight.

What will matter most to your portfolio going forward?  

First off, expect more volatility. More ups and downs in the markets. More uncertainty. And loads more unpredictability. We can’t bank on the Fed doing anything. Since the data that comes out each month seems to surprise everyone. And right when we think we’ve got inflation under control it turns out that it we’re a tad wrong since it’s just too sticky right now. But the one thing you should avoid doing is trying to predict what’s going to happen. 

Instead, make sure your portfolio is well diversified and that it’s ready for a range of outcomes (unless you wanna keep changing your asset allocation every 3 weeks – which is NOT efficient and also pretty hard as a one-man-band). This means you should not just be exposed to (US) tech.

You should be having exposure to different countries since some will do well while others do badly. Now, China is struggling with a sluggish economy and low inflation while the US is red-hot on those fronts. You should also consider what types of sectors you’ve got exposure to. 

Sectors like financials (banks, insurance firms, money managers) tend to hold up pretty well in this kind of scenario.

Banks for ex get to charge a higher % on their loans (yup, anyone taking a mortgage out now can testify how painful that is) while they don’t exactly pay that same % on their deposits!! Insurance firms earn higher % on their bond investments (till recently it was pretty much nill) that earn a higher income that backs the policies they write.

So make sure you’re diversified and have a decent exposure to a range of different sectors since it’s dangerous to bank on any one single outcome. And just because something’s worked in the past doesn’t mean it’ll continue doing so. 

So given all this noise and total unpredictability, here are 3 things I’m thinking about when it comes to protecting my portfolio in these weird times. 

#1 Active v passive 

The active v passive debate is one that never sleeps! I was chatting to a colleague and we both admitted we love active funds and since we work in the investment management industry we’d be the biggest pack of hypocrites if we favoured index investing rather than a fund manager to do the job for us.

But in recent years with the epic bull-run in the US, owning the S&P 500 (or the Nasdaq for that matter) was really all anyone ever needed. It was the best cake in town. And according to Buffett (and loads of others) it’s really all you need. 

But they’re not as perfect as they seem. Index funds track a particular market/sector like the S&P 500. When times are good (like they’ve been in the US ever since ‘09) then the index does well but in bad times the index does badly. You get the rubbish stuff with the good stuff. That’s why for this particular market active management usually does better than passive. 

Active management can shine when times are rough. Which means they should (in theory – and hopefully in practice too!) suffer less in a bear market than their passive peers since for an index fund there’s no way out.

You own the whole pack. Including the crap parts that you’d wanna get rid of in a downturn (cough, cough overpriced stocks). Someone joked to me once that passive investing in a bear market is like diving off the top board without trunks.

You get the picture. There really is a time and place for everything and for many the answer is having a combo of active + passive stuff in your portfolio. Whatever you have, always be prepared for the worst. And hoping for the best of course! 

#2 Real assets 

Real assets incl things like:
-commodities (oil/gas/gold/other metals)
-real estate
-infrastructure 

Real assets are things you’ll wanna own in times of high interest rates. High rates mean that inflation is still slushing around which bodes well for these sorts of assets. When prices are rising it usually comes from the underlying inputs: like oil, like gas and metals.

When oil fell to $85 p/barrel it did a lot of the heavy lifting for bringing inflation back to more normal levels. These companies are also dividend-payers which means you’ll get regular income if you invest into these stocks – always handy! Especially when your bank deposits are now competing for your capital. 

In this bucket we’ve got infrastructure – these are things like toll roads/bridges/hospitals and so on. Basically the boring but super important stuff for society to function. There are infrastructure funds that yield decent % – but make sure you’re happy with the exposure i.e brownfield vs greenfield infrastructure.

Brownfield = existing infrastructure so it’s much safer vs greenfield = building new infrastructure. You can also have infrastructure funds that primarily invest in developing economies’ infrastructure – as you can imagine the risk/reward payoff is much higher. So have a dig around and see if any of this stuff is useful for your portfolio. The yields are pretty good and they’re also relatively low risk. 

Then you’ve got real estate. There’s so many buckets here but let’s split it into residential and commercial. Residential = apartment blocks/houses (the stuff you and I buy) and commercial real estate = offices, warehouses, shopping malls, hotels ect.

Obvs, the valuation for office buildings has fallen massively thanks to this WFH biz that refuses to shut down! But luckily the real estate universe is pretty big and usually diversified – so pay attention to the fund’s underlying categories. This asset class holds up well in inflation since rents tend to increase with inflation so giving you a built-in form of protection. 

You can get exposure to real estate via REITs (real estate investment trusts) – these are listed vehicles and they dish out 90% of their income (aka rents) to shareholders and they get corp tax perks by doing so. Which makes them pretty good sources of alternative income through decent yields (income/price).

So have a look around and maybe have a think about gaining some exposure to these areas. Also, as interest rates fall this should be a good thing for REITs since their cost of borrowing falls and valuation goes up (higher rates = lower val; lower rates = higher val). 

#3 Digital asset 

I say asset (not assetS) because Bitcoin is the only one on my mind right now. Bitcoin is digitally scarce – which makes it the perfect hedge against inflation. I know what you’re gonna say – with rates higher for longer and bitcoin not generating any income (or any cash flow for that matter) what’s the point in owning it? Great Q.

I like to think of Bitcoin as a bet on the future of money. It’s a totally decentralised entity (not controlled by anyone or group of anyone’s) which means they can’t fiddle around with the cost of money or the supply of money. There’s 21 million coins. No more, no less. 

And we could get to a situation where the Fed holds a loose inflation rate (so letting prices rise by >2% annually) which means our currency will slowly but surely get debased – losing its value and purchasing power.

Bitcoin can help solve that. I’ve no idea how it’ll perform in the near term I just know it’s an asset I’m willing to bet my money on in the long run that it can actually change the way we view money and offer us some sort of inflation protection should things go wild. 

So, there you have it. Some stuff that’s on my mind right now! Make of it what you will.

Disclaimer: This blog is not investment or financial advice. It is my opinion only. This blog is not a personal recommendation to buy/sell any security, or to adopt any such investment strategy. Always do your own research before you commit to any investment.