‘It’s only when the tide goes out that you learn who’s been swimming naked’.
Warren Buffet said that back in 1992 in the context of weather events hitting insurance companies. But the quote could just easily be used for when the Fed starts to raise rates and the tide of liquidity starts to recede. After all, when interest rates are stuck at zero and investors can leverage easily, then all sorts of investments look attractive, whether they make a profit or not. However, the Fed ends its liquidity injections, then the true fundamentals of assets get revealed.
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‘It’s only when the tide goes out that you learn who’s been swimming naked’.
Warren Buffet said that back in 1992 in the context of weather events hitting insurance companies. But the quote could just easily be used for when the Fed starts to raise rates and the tide of liquidity starts to recede. After all, when interest rates are stuck at zero and investors can leverage easily, then all sorts of investments look attractive, whether they make a profit or not. However, the Fed ends its liquidity injections, then the true fundamentals of assets get revealed.
We’re getting a taste of this already. So far this year, the S&P500 is down almost 8%, NASDAQ is down 12% and bitcoin is down 24%. Meanwhile, the market has gone from pricing three Fed hikes to four for 2022. On top of that the huge US fiscal stimulus of 2021, which consisted of direct payments to households – much of which was used to invest in markets, won’t be repeated in 2022. So, it’s a double-whammy – the Fed is raising rates and the fiscal stimulus is disappearing. This means it will be a tough year for markets.
It also tells us that inflation doesn’t always hurt investors – remember last year US inflation jumped to 7% but US stocks rallied 27% and gold prices fell 4%. Rather, the Fed cycle can matter more. When the Fed shifted its stance and decided to pivot to aggressive tightening, that’s when markets took notice. They’ve been volatile ever since (Chart 1). This reveals that inflation wasn’t hurting company profits (they went up), but rather the end of easy money is hurting market valuations.
The punchline is that this year will be a tough year for growth markets whether equities or crypto. We’d be defensive – that means sticking to investments with good fundamentals, and not being afraid to hold cash (to be ready to buy distressed assets). Good luck.