Model Portfolio Update – December 2022

Global Liquidity Growth in October (the latest available month) of (6%) was far below the trend growth of 7% and may be close to bottoming in the next few months. Global Liquidity has been below trend since November 2021 and the trend-following portfolios have been allocated to the Safety portfolio since January 2022 generally as a result of lower-than-trend Global Liquidity growth. Long Duration Equity/Bonds Returns tend to be positively correlated with Liquidity Growth. With weak general liquidity/funding conditions, allocation to the Safety portfolio is prudent. Gold has replaced the US dollar in the safety portfolio this month. As we cover in the previous post, Historically, Bear markets lasting > 1 year and subsequent recessions have resulted in significant drawdowns (~45% for S&P 500) and last 18 months on average. The current bear market has been about 11 months, so we may be only halfway through the bottom and start of a new bull market. Generally, a bottom is formed when global liquidity turns positive and the yield curve slope has positive momentum.  

 

Looking at the Fed Funds Rate and comparing it against historical levels of the Fed Funds Rate and inflation may understate the tightening of monetary conditions we have seen in 2022. A proxy rate or a shadow interest rate can be interpreted as indicating what the federal funds rate would typically be associated with prevailing financial market conditions (including the impact of Quantitative Tightening and altering of Forward Guidance, the strength of US dollar, and energy prices) if the fed funds rate were the only monetary policy tool being used and would peg the rate closer to 6.6% rather than current rate of 4.0%, which is much closer to where core inflation rate is running.     

We use cyclical indicators of the business cycle including Long-leading indicators and Short-leading indicators to help determine the forward-looking economic outlook. Long-leading indicators tend to turn 15 months ahead of the recession and Short-leading indicators are 7 months ahead of a recession. So we use short-leading indicators to confirm our long-leading indicators. As of the latest month, all Long-leading indicators are negative and Short-leading indicators (excluding labor market indicators) are negative as well. Labor markets have remained strong, though high-frequency data (daily treasury/tax data, initial claims, contractors) on the labor market appears to show continuing slowing of growth into 2023. Both the yield curve and long-leading indicators suggest that the probability of recession to above historically recession triggers (50-80%) over the next 12 months. 

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