Investors may make midyear financial adjustments to combat inflation and rising rates

December 23, 2022

  • Patrick Dolle - J.P. Morgan Private Bank,

The post-COVID-19 bull market has come to an end — we are officially in bear territory. Our outlook is more challenged than we expected at the start of the year due to the Fed’s tightening campaign, the war in Ukraine, and rising COVID-19 cases in China.

Rising rates and inflation are impacting the Cincinnati market given the strong manufacturing base within the community. We are also seeing these factors affect M&A activity; however, the deal flow remains healthy. While the current market volatility is concerning to investors, opportunities remain for those who are focused on investing for the long-term.

Inflation, rising rates and the impact on manufacturing

Inflation has dominated the headlines this year, and consumers have felt it hit their wallets — to a significant degree, as U.S. inflation is at its multi-decade high. And it’s not just consumers. Manufacturers too have felt the impact of inflation and have had to raise their rates to cover the increase in costs.

The headline-making inflation rate is driven in part by pandemic-era disruptions which have started to subside, with inventory levels rising and inventory to-sales ratios recovering. Consumers have started shifting from goods to service purchases — just look at summer air travel as an indicator.

There is also growing evidence of excess supply in the trucking industry with global shipping rates rolling over, suggesting a portion of the inflation we have seen over the last 18 months was related to COVID-19. Even in the absence of Fed policy action, inflation may partially normalize as the pandemic wanes.

The Fed’s plan to aggressively raise policy rates is the fastest hiking cycle since the 1990s. Although the Fed has only just begun its hiking cycle, we are already seeing the desired impact of slowing economic activity — one example being the housing market, the U.S. economy’s most interest-rate-sensitive sector.

As we move into the second half of the year, we will start to see more signs this rate-hiking cycle is accelerating an economic slowdown that was set to happen naturally as the pandemic era stimulus receded.

Prioritizing balance and quality in equity portfolios

We expect trend-like earnings growth through the balance of the year. Across a variety of sectors, we see opportunities with high-quality businesses that provide earnings stability and visibility. Health care, industrials and technology are our three favorite equity sectors.

Mature health care companies seem particularly compelling as they will benefit from a strong demographic tailwind, solid drug development, a history of defensiveness in volatile markets, and the potential for merger and acquisition activity. Another reason: health care companies tend to have strong balance sheets and consistent earnings growth. Their management teams are reliable capital allocators, and they are usually good partners to investors. Consistent dividend growth can be an indicator of quality.

Positioning for structural change

The next cycle will likely feature reconceived and restructured global supply chains with manufacturers bringing their factories onshore and more autonomous for efficiency as geopolitics and the potential for future pandemics prompt business leaders to add resiliency. For investors, this means increased opportunities for robotics and related hardware and software.

Revisiting your plan during periods of volatility can provide an opportunity to help ensure you stay on track so that your near-term goals are more insulated while the long-term goals remain achievable.

This story originally appeared in Cincinnati Business Courier.