The Conundrum: March 2024 Market Trends Report

The Federal Reserve has found itself behind the curve in recent years, as growth and inflation have moved in tandem. 

This means that every growth acceleration has been accompanied by accelerating inflation, which forces the Fed to tighten policy and kill growth. This is in stark contrast to the previous policy following the Global Financial Crisis (GFC), when the Fed met every decline in growth with stimulus, such as quantitative easing (QE).

There are a number of factors contributing to this new dynamic. 

• First, the economy is transitioning from globalization to deglobalization, making it more difficult for central banks to control inflation. (Chris McAlpin touched upon this briefly during our client update back in December.)
• Second, technological innovation has led to a more dynamic economy, with new businesses and technologies emerging at a rapid pace. This makes it difficult for central banks to keep up with changes in the economy and predict the impact of new technologies on inflation.
• Third, the role of monetary policy has changed in recent years. After the GFC, central banks around the world adopted a new policy framework known as “flexible inflation targeting.” 

Under this framework, central banks aim to keep inflation at a target level, but they are also willing to tolerate some deviation from the target in order to support growth. This new framework has made it more difficult for central banks to raise interest rates in response to rising inflation, as they are reluctant to do so if they believe that doing so will slow down growth too much.

More proactive approach to monetary policy

One possible way for the Fed to address this issue is to adopt a more proactive approach to monetary policy. Another option would be to stop communicating policy so frequently. It has only been since 2011 that the Fed started giving press conferences to discuss monetary policy. I believe the frequent communication has delayed the transmission mechanism, potentially eroding policy effectiveness in more condensed cycles.

In the meantime, our investment framework has undergone some notable changes over the last month. We have downgraded market sentiment, as intermarket relationships and market

internals have deteriorated. However, the business cycle, monetary policy, and valuation components have not changed.

Are leading indicators still negative?

Yes. However, they are getting less bad, and we expect them to recover this year. Inflation is likely to accompany growth, adding credence to the “Fed Conundrum.” However, coincident indicators like real retail sales, industrial production, and employment levels have slowed considerably.

The investment outlook remains consistent with the cycle. The high-quality factor remains the top factor from a relative strength perspective, consistent with a growth-slowing environment. Long-term opportunities exist in real assets, international equities, smallcaps, and value stocks, but these areas are not in favor on a relative basis. 

Therefore, patience is key. I also believe that trend following, which we believe is having a great year so far, should be the core of one’s allocation.