By Michael O’Connor

I spoke last week about the fragility of the most recent upward trend in markets.

We are in the interlude between inflation peaking and economic data slowing, a momentary sweet spot if you will.

Well, the interlude is over, and the sweet spot is no more, ground to a shuddering halt by a direct and concise message of intent from Fed chair Jerome Powell on Friday.

“While higher interest rates, slower growth, and softer labour market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation but a failure to restore price stability would mean far greater pain.”

In short, don’t be surprised to see more market volatility and economic pain as interest rates continue to rise in an effort to cool inflation.

Sometimes pain is for the greater good, apparently.

Outlook

After clawing back over 50% of their losses, stocks are at a crossroads.

As we move away from inflationary woes toward economic growth concerns, market uncertainty will most likely result in back-and-forth trading with no clear direction in site.

As I mentioned previously, the V-shaped recoveries we have come to know and love over the last 2+ years are far less likely.

The liquidity and support that fuelled previous reversals are now being stripped out of markets. Fundamentals will continue to be reset to account for this.

Expectations will need to be moderate as we enter a period of slower growth.

My Predictions

None of the major asset classes looks overly attractive in this market over the short term.

Stocks and bonds continue to reset, and the point of entry remains unclear given the risks that remain.

With that said, buyers remain on the sidelines and using any pullbacks as a chance to top up on high-quality stocks with strong free cash flow is advised.

Although fundamentals are being reset as future earnings get revised downwards, many of these high-quality names are more profitable than ever and have the capital on hand to buy-up market opportunities where they see fit.

Funding these purchases by reducing your positions in non-profitable growth is also advised.

Many of the pandemic high-flyers will continue to bleed out.

Supply/demand issues should keep oil prices elevated over the medium term but expect considerable volatility. Some high dividend energy companies should provide some attractive yields in the process.

Bonds continue to add to their allure as the equity risk premium gets reduced, but interest rates have yet to reach their ceiling. With that said, the 10-year Treasury at 3.5% seems like a solid entry point to build up long-term exposure.

While I believe that interest rates will be higher for longer, I don’t believe that rates can remain elevated for very long, making treasuries an interesting investment.

The current aggressive Fed policy that brings interest rates to these higher levels will initiate an economic slowdown that is only alleviated by reducing the very rates that caused the slowdown in the first place.

And round and round we go.

For free weekly stock tips and direct access to my personal investment portfolio, go to www.theislandinvestor.com.