December was a choppy month for stocks but finished on a high note, as stocks enjoyed a late Christmas rally to close out the year. January on the other hand has gotten off to a much more active start, with tech stocks falling into correction territory (-10%), as the Fed and other Central Banks take a more hawkish view on the inflation outlook. The less accommodative Central Bank posture has led to a rise in bond yields, which has dampened risk appetite for equities, particularly those with elevated valuations due to the mechanical effects of a higher discount rate. For this reason, among others, we continue to prefer a more value-centric equity tilt, with a focus on quality.
Dividend stocks have done well over the past six months, particularly the energy sector; and with the global oil market still pretty tight, there could be additional room to run, especially with geopolitical risk in the Middle East and Europe at the highest levels of the past few years.
Specific to fixed income, we continue to recommend shorter duration strategies due to the continued rise in inflation and bond yields. While the Fed is actively trying to lower inflation, a portion of it may be out of their control, as supply chains and labor markets are playing an active role in the inflation story (the Fed’s tools may be somewhat limited in this regard). This is particularly true if energy prices continue to rise due to idiosyncratic factors.
To visualize the continued stress in supply chains, we have provided the chart (right), courtesy of Oxford Economics and Haver Analytics, which breaks out the supply chain composition.