Viewpoint | January 17, 2023
A New Reality
In our somber-minded daily world of earning a living we occasionally wander into a dreamworld of a living earned for us. This has led us into historical financial fantasies such as the South Sea Bubble, the Dutch tulip craze, the gold rush, the internet mania etc. etc.
Over a decade ago we embarked on a contemporary version of the pursuit of El Dorado, a mythical world of plenty, a virtual world of everything.
It was a voyage like few others. It began most humbly. It grew out of the financial carnage of the great recession of 2008. But soon the powerful forces of monetary and fiscal stimulation started to make themselves felt and they propelled us forward at increasingly dizzying speeds. The stock market was going up, the bond market was going up, we were getting rich. The wind was at our backs. To be sure there were squalls on the way (the European banking crisis, the energy crisis, the Brexit crisis, the Covid crisis etc. etc.) but throughout it all we were scudding forward with ever-lower interest rates.
It was a trip that gave us glimpses of a magic kingdom called WeWork (that, according to one investment bank, was worth US$90 billion). There were sightings of splendid electric vehicles noiselessly floating on valuation clouds never seen before. There were creations such as Nikola, a truck company that, motorless, rolled along on valuations in the billions. There were SPACS galore, shooting stars splendid to behold in their temporary glimmer of tinsel wealth. What a glorious period to venture forth and follow the rainbow of venture capital. Fiscal and monetary winds moved us ever forward in our voyage towards untold riches. We had a vision of money from heaven and called it cryptocurrency. The rainbow was ours to touch.
It was a year ago, January 2022, that our financial voyage to a meta universe started to reverse direction. The stock market stopped climbing, interest rates began to go up, bond prices declined, and unexpectedly inflation became a topic of concern. Growth stocks started to come under pressure and venture capital projections began to be questioned. Suddenly, the assumptions of just a few months ago no longer seemed that relevant. Increasing numbers of financial experts started talking about profits, cash flows and price earnings ratios. It was hard to believe and difficult to digest for so many whose minds were programmed to buy on dips. Retail buyers continued to be bullish and were net buyers of some 100 billion in US equities in 2022.
Last year witnessed a sharp correction in both equity and bond markets. This was followed by a relief rally in the last few months that retraced almost half of the losses experienced earlier in 2022. Optimism started to reappear as we received comforting news that inflation may have peaked, that recession may be avoided and that the Fed may be moderating its tightening policies.
It is impossible to predict short term market turns but we need to understand that we are in a period of major transition, a period of change and greater unpredictability. More than a decade of very low inflation and interest rates has come to an end. Our world of ever greater global inter-dependence linked together by smooth flowing international supply chains is changing. Onshoring or nearshoring will play a much greater role in the future and will result in higher underlying prices. Our energy landscape, due to evolving political and climate change priorities, is changing and will result in higher underlying energy costs. Our increasing socio-political emphasis on reducing inequality will lead to higher minimum wage structures which, in turn, will lead to higher prices. The struggle of the previous decade to fight disinflation and get inflation higher to a goal of 2% will now turn to a struggle to control inflation and get it down to 2%.
We must approach this period of transition with care and prudence. We must adapt our investment attitudes to reflect these new circumstances. Markets will need some time to adjust to a new reality. It seems too early to go back into yesterday's strategies of growth equities and longer-dated government bonds. We must be particularly careful of duration risk since higher underlying inflation will erode the purchasing power of our portfolios. We should keep duration relatively short and focus on better-quality credits in the BB/BBB area. We believe there is only modest risk of significant spread widening. We believe default rates will stay relatively constrained since many companies were able to refinance at very attractive rates over the last few years. We believe portfolios with significant participations in floating-rate and short duration credit strategies will prove to be particularly rewarding in this period of transition and uncertainty.
Capital at risk. The value of investments and the income from them may fall as well as rise and is not guaranteed. Investors may not get back the full amount invested. Past performance is not a reliable indicator of current or future results.
This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of January 2023 and may change without notice.
Muzinich and/or Muzinich & Co. referenced herein is defined as Muzinich & Co., Inc. and its affiliates. Muzinich views and opinions. This material has been produced for information purposes only and as such the views contained herein are not to be taken as investment advice. Opinions are as of date of publication and are subject to change without reference or notification to you. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments and the income from them may fall as well as rise and is not guaranteed and investors may not get back the full amount invested. Rates of exchange may cause the value of investments to rise or fall. Emerging Markets may be more risky than more developed markets for a variety of reasons, including but not limited to, increased political, social and economic instability; heightened pricing volatility and reduced market liquidity.
Any research in this document has been obtained and may have been acted on by Muzinich for its own purpose. The results of such research are being made available for information purposes and no assurances are made as to their accuracy. Opinions and statements of financial market trends that are based on market conditions constitute our judgment and this judgment may prove to be wrong. The views and opinions expressed should not be construed as an offer to buy or sell or invitation to engage in any investment activity, they are for information purposes only.
This discussion material contains forward-looking statements, which give current expectations of a fund’s future activities and future performance. Any or all forward-looking statements in this material may turn out to be incorrect. They can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Although the assumptions underlying the forward-looking statements contained herein are believed to be reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurances that the forward-looking statements included in this discussion material will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation that the objectives and plans discussed herein will be achieved. Further, no person undertakes any obligation to revise such forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
United States: This material is for Institutional Investor use only – not for retail distribution. Muzinich & Co., Inc. is a registered investment adviser with the Securities and Exchange Commission (SEC). Muzinich & Co., Inc.’s being a Registered Investment Adviser with the SEC in no way shall imply a certain level of skill or training or any authorization or approval by the SEC.
Issued in the European Union by Muzinich & Co. (Ireland) Limited, which is authorized and regulated by the Central Bank of Ireland. Registered in Ireland, Company Registration No. 307511. Registered address: 32 Molesworth Street, Dublin 2, D02 Y512, Ireland. Issued in Switzerland by Muzinich & Co. (Switzerland) AG. Registered in Switzerland No. CHE-389.422.108. Registered address: Tödistrasse 5, 8002 Zurich, Switzerland. Issued in Singapore and Hong Kong by Muzinich & Co. (Singapore) Pte. Limited, which is licensed and regulated by the Monetary Authority of Singapore. Registered in Singapore No. 201624477K. Registered address: 6 Battery Road, #26-05, Singapore, 049909. Issued in all other jurisdictions (excluding the U.S.) by Muzinich & Co. Limited. which is authorized and regulated by the Financial Conduct Authority. Registered in England and Wales No. 3852444. Registered address: 8 Hanover Street, London W1S 1YQ, United Kingdom. 2023-01-17-10099