We expect equities will remain volatile given the many uncertainties tied to inflation, monetary policy, global growth, geopolitical tensions, the midterm elections, supply disruptions, and Covid-19. While we see a path to a soft landing given underlying economic strength and a resilient consumer, the Federal Reserve must thread a needle to slow demand without squashing job creation. Still, futures discount a fairly aggressive tightening cycle, with an implied peak fed funds rate of +3.0 percent by April 2023. In addition, the Fed will begin reducing its bloated balance sheet this month, adding another headwind to the economy and financial markets. Nonetheless, there is gathering evidence that the year-over-year growth rate in inflation is peaking, which may provide the Fed room to maneuver more judiciously.
In terms of investment strategy, portfolios favor domestic exposure as the stronger trade-weighted U.S. dollar will pressure the earnings of multinational companies. Moreover, now that valuations are more reasonable, we added to select positions in secular growth tech, especially within software and services, as earnings should prove resilient against a challenging economic backdrop. Healthcare also remains a favored sector, given its inherent stability. Finally, we incrementally increased energy exposure on pullbacks as we believe years of industry underinvestment, ongoing production restraint among U.S. producers, and increasingly limited capacity for OPEC+ to ramp production will support oil prices.
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