Mid-Quarter Update

EPIQ Playbook as Markets Respond to Economic Transition 

With the quarter half over, it’s an opportune time to share our thoughts on current market volatility as well as our investment strategy moving forward. Financial markets have swiftly incorporated changing expectations for inflation and subsequent adjustments in monetary and fiscal policy. Rumbles of conflict between Russia and Ukraine further exacerbate global uncertainty.  Public health response to the pandemic continues to vary state to state, creating additional volatility despite appearances that the pandemic may be dissipating.

Inflation and interest rates are spooking the market.  The Consumer Price Index (CPI) increased 7.5% in January, reaching a 40-year high. Current reports indicate that the Fed will now sharply increase short-term rates from zero to 2% over the next 18 months. Historically, returns for stocks and bonds are challenged during periods of rising rates, though markets generally do a good job of anticipating these changes months prior to both the onset and end of rate adjustments.  Interest rate changes have a greater impact on stocks, but bonds are affected too.  Even less risky bonds have declined in nominal and real terms year-to-date.

We expect one of two scenarios: 

·     Scenario 1: Inflation peaks by the second quarter and then begins subsiding. There will be lumpiness as one-time events distort figures in the near term. Productivity gains should continue to provide optimism for future returns, while healthy fundamentals sustain economic growth.  While growth will slow, inflation concerns should decline faster as pandemic-induced supply-chain issues dissipate.

·     Scenario 2: Risks of inflation remain elevated, and the cycle of higher prices becomes embedded due to commodity and labor shortages. If this situation develops, central banks globally will likely raise rates more aggressively than currently expected. This would result in greater pressure on multiples resulting in lower stock and bond prices.

Our playbook for this environment.  EPIQ’s long-term time horizon, focus on investing rather than speculating and our customized approach to portfolio diversification are beneficial in volatile markets.  Characterized as Preservation, Income or Appreciation, all EPIQ accounts are separately constructed.  Our playbook begins with assessing each account’s position to confirm that the mix remains appropriate for the client’s objectives and constraints given our market outlook and adjusting if or when necessary.

We expect equity markets to remain choppy for the next 6-9 months. Over time equities have proven to be the best defense against the ravages of inflation. Equity earnings may fluctuate but faster earnings growth can outpace inflation, providing support for valuations even while price/earnings multiples are compressed.  Still, the prices of many smaller company stocks, especially those not yet profitable, have fallen so quickly that we see considerably more upside than downside at this point.

With the US 10-Year Treasury Note now yielding 2%, value is slowly returning to the fixed-income market. The real yield is still negative, however if inflation declines as expected over the next 12-18 months, bond buyers may be able to earn a positive real return from the yield alone. This has not occurred for nearly 15 years. 

We remain encouraged with our limited exposure to traditional fixed-income and our broad-based equity exposure. Alternative investment classes (e.g. private equity, real estate) provide better insulation from daily swings in the public markets.  As over half of all companies reporting year-end results, we are reassured that EPIQ’s portfolios are well positioned to benefit from the value creation embedded in company operations. 

As always, thank you for your confidence and trust. Please contact us to continue the conversation.   

EPIQ Partners