4 ways to cover falling profits

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  • Brent Schutte believes that the Fed risks pushing the US economy into a deflationary environment.
  • Quantitative tightening combined with massive rate hikes could “eviscerate” consumers, Schutte said.
  • He shared four asset classes to hedge against the decline in earnings anticipated by many analysts.

Whereas stubbornly persistent inflation has recently been a priority for most investors lately Brent Schutte is increasingly worried about the opposite case: deflation.

Deflation, or general decline in prices in an economyis a term that has rarely been discussed in the past two years – not since the pandemic and its association supply chain constraints catapulted prices in the United States to forty-year highs. But Schutte, who is chief investment officer at Northwestern Mutual Wealth Management Company, believes the phenomenon may not be as far off as one might think.

“From 2014 to 2020, we were all worried about deflation; that’s what everyone wanted to talk about. Now the Federal Reserve – which wanted to raise inflation expectations – has kind of brought them down to a normal level of what we were seeing before -2014,” Schutte told Insider in a recent interview. “My comment is: Land the plane. »

“At some point, I just think the Fed needs to slow down because it risks taking us back to where we were in some of these deflationary years,” he continued.

Inflation will not persist at high levels

While Schutte agrees that inflation has been much more rigid than investors initially thought, he struggles to see how inflation remains permanently high. Overwhelming consumer demand has already begun to subside, giving supply a chance to catch up with demand. Consumers may have shifted their spending from the goods sector to the services sector, but overall spending was up just 1.8% year over year and has been particularly weak over the past four past few months, Schutte said.

“When demand and supply are more aligned, inflation generally falls, unless you expect it to stay high, which I just don’t see happening,” he said. Explain.

But the Federal Reserve’s biggest mistake, according to Schutte, is that it made monetary policy decisions based on historical economic data rather than forward-looking data, which could better inform the central bank of an upcoming slowdown. of inflation.

“I wonder how variable the monetary policy lag really is, and how much they’re now starting to risk going too far and breaking something,” Schutte said. He believes the Fed has raised interest rates several times this year to staggering 75 basis point increases because it is reluctant to repeat last year’s mistake of doing too little for too long. before tackling the problem.

Schutte also fears that the Fed will lose control of the economy with its balance sheet reductionthat economists like Mohamed El-Erian have warned could have massive and unpredictable recessionary ramifications.

But once the economy hits a slowdown, Schutte thinks inflation won’t continue to persist. In fact, he worries that a possible recession might work out a little too well, as US households, while in good financial health, are still sensitive to inflation, as indicated by the recent pullback in demand.

“I don’t think we have to gut the consumer and make them poor again, or make their balance sheet really weak again to bring inflation back into the box,” he said. “That’s where I kind of find central banking a little weird these days, because some people think we need to bring the consumer back to where they were in 2008.”

Buy cheap assets to hedge against falling profits

While the stock market’s year-to-date decline is certainly concerning, Schutte is less obsessed with selling, as he believes it’s a natural revaluation of the “hopes, dreams and memes” assets whose valuations have soared over the past year.

In fact, Schutte sees investment opportunities in areas of the market where valuations are still very cheap, especially since these cheaper assets can help investors hedge against falling earnings, which he says , could continue to fall. “We’ve kind of positioned more of our portfolio towards the parts of the market that are cheaper and have a large safety net against declining earnings,” he said.

For example, currently Schutte has built a position in value stocks – especially those that are cheaper in the US – as he believes they are still out of favor with investors. In practice, this means that Schutte holds the cheapest stocks in all parts of the market, which also makes this strategy sector neutral.

“You want to be in things that have real cash flow,” Schutte said, adding, “I think value is going to do a lot better as a factor, as a style, and things that are less expensive ones will do better than things that are more thematic in nature.

Moreover, Schutte continues to cling to his goods assets. “We have owned commodities for years, based on our belief that inflation would be a possibility,” he explained.

Schutte also has a broad and diverse exposure to low quality- and mid cap stocks in the United States, which he says has already performed relatively well so far in 2022.

“Certainly we are moving the pieces,” Schutte concluded. “But the most important thing is to stay the course.”

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