• As inflation risks remain high, against a backdrop in which supply chain disruptions have been somewhat worse than expected—as the Omicron surge in China triggered a renewed and drastic tightening of virus-related restrictions, and Russia’s invasion of Ukraine has caused sharp increases in food, energy, and metal prices— the market has increasingly been leaning toward a more aggressive monetary normalization process than the one set by the Fed just a few weeks ago—or, to put it another way,, the guidance for federal funds rates over the next two years (2.8%) could end up being brought forward almost entirely to this year. 
• Of course, this is putting additional pressure on market rates, with the 2-year Treasury yielding over 2.6% and 10-year rates near 3.0%.
• While risks remain, in principle, we are inclined to believe that base rates are already reaching a “significant peak” (not necessarily the end of this rate-hiking cycle, but a pause and some reversal seem reasonable), since several divergences we observed in previous months—between interest rates and inflation levels, as well as real interest rates that were very low compared to other rate-hiking cycles—have been narrowing.  
• While the 10y2y yield curve has briefly inverted, other measures of the curve remain positive (10y3m). These measures indicate that the market expects the Fed to raise the federal funds rate over the next year and a half, which would not be consistent with an imminent recession.
• The time between the investment and the recession can be long. On average, the S&P 500 has risen by 15% following yield curve inversions.
• In terms of strategy, we maintain a view that remains positive toward risk, and recent pullbacks are providing better entry points from a tactical perspective. We continue to recommend an overweight position in equities and commodities and an underweight position in bonds, although interest rate levels already appear “more attractive,” especially in investment-grade (IG) bonds. Following a decline of more than 15% from Q4 2021 highs, U.S. investment-grade debt may well represent a “tactical opportunity” within a diversified portfolio and a barbell strategy.
• Before the war in Ukraine, growth was expected to accelerate well above trend as we emerged from the Omicron wave and saw pent-up demand from consumers and businesses unleash. Although growth forecasts have been revised downward in recent weeks, much of this momentum remains, and we still see support from strong labor markets, light investor positioning, healthy corporate and consumer balance sheets, easing monetary policy in China, and fiscal support in several countries, which help offset some of the drag from high energy prices. 
• We continue to favor value sectors, which are more closely tied to the “real economy,” sensitive to higher inflation, “short in duration,” and therefore less sensitive to higher interest rates.
• With the risks of a recession still limited, we see opportunities in the small-cap segments.
• Finally, we recommend being selective in growth sectors that are most sensitive to higher interest rates. Software multiples are now close to pre-pandemic levels. However, growth expectations remain stable. Valuations have contracted, while rates are still relatively consistent with the levels observed during the most recent previous peak (2018).

For more details and investment opportunities, see the attached report.

Humberto Mora

Investment, Finance, and Business Manager; Stockbroker