The Re-emergence of the Fed put

If we go back to late 2020 or early 2021, it is now quite apparent that central banks made a sizeable error by keeping monetary policy too lax for too long. That opened the door for the demon inflation to emerge. During this period, I have contended that an error was made but we did not know what price we have to pay for that error.

The bull scenario was a muddle through with inflation getting back into the box with a strong monetary response but not one strong enough to strangle the economy. The bear case was that the economy would be strangled as much tighter conditions were required. As an aside it is not good enough, imo, to just say we will have a recession, as those of us that have been through a few will attest it quickly becomes an assessment of what type of recession we are actually in, a “technical” recession, ie very soft, or a market clearing, gut wrenching recession, or any of the thousand variants in between. As you can expect the perma-bull and perma-bears take their expected positions on that.

Nothing is written in stone and no one knows the future but it is helpful to think about the issue in terms of probabilities and likelihood of occurrence and how those probabilities change over time and how that should be reflected in your risk appetite. ( I actually think about this a lot)

The big issue, imo, is not a recession or no recession per se, but the ability of the Fed to react to any big negative issues that are put to the economy. When we had inflation bouncing along in its unpredictable and destructive path, the ability of the Fed to react to any large negative issues was dangerously impeded, imo. The Fed would be placed into the predicament of loosening policy into high existing inflation and then could only hope that the problem quickly go away, the prospect of a long battle would be frightening. The equivalent of fighting on two conflicting fronts. The destruction of Fed credibility would be an issue and that opens a whole Pandora's box that we don’t want opened.

During 2023 we have now seen enough to say, imo, with the retreat of inflation, that the Fed has its flexibility back and it can fight a systemic issue and keep its credibility. The implication to markets and risks involved are quite large and are bullish.

My investing style is to attempt to see where the world will be in 12-18 months and play that game rather than playing off the pitch. 2023 has been a march largely in a positive direction.

What does this mean for equity strategy? I have been largely fully invested in 2023 but quite defensive as more evidence was required to move out the risk curve, imo. IMO we are now in a position where some more risk can be taken based on the facts rather than just hoping. Of course we all hope as well.

That’s my view could be wrong.