Why post-recession era could ring in shorter, sharper, more volatile cycles

Michael White, a portfolio manager, is interested in what the markets are going to look like coming out of a recession – and he said advisors should begin to position for that, too.

“What interests me most is what we will end up with coming out of all this,” Michael White, partner and portfolio manager of multi-asset strategies at Picton Mahoney Asset Management, told Wealth Professional, as he looked at all of the headwinds these days.

He noted Picton Mahoney started the year expecting significant headwinds with high valuations, creeping inflation, interest rate hikes, Russia’s war on Ukraine, and China’s COVID lockdowns. But, it expected those to turn into tailwinds toward the end of the year.

“I think where we’ve been a little bit off is just with respect to timing. Inflation has remained stickier than we thought it would be,” he said.

“There are a lot of ingredients in place for a potential rally, not the least of which is under-positioned investors. But, there doesn’t seem to be a lot of risk appetite out there in the marketplace right now. So that could be some nice kindling for a rally.”

White thinks all the interest rate hikes will force a recession, he said Picton Mahoney is expecting the environment that could emerge from that will look like the 1960s and early 1970s, where investment and economic cycles were shorter and more violent, seesawing between inflation and disinflation.

“That will probably make for shorter, more volatile cycles going forward,” he said, noting that he’s already looking at how to build portfolios when the traditional 60/40 portfolio allocation that has benefitted investors for the past four decades with declining interest rates won’t work as well.

“If we’re in a new environment over the next decade, or more, where cycles are shorter and more violent, portfolios need to be better diversified and have more inflation exposure built into them, and maybe being more tactical with some of those traditional assets, like stocks and bonds,” he said. “So, it’s really having a better framework to seek out more diversification to return.”

White is expecting a decent equity rally, but said advisors should not put all of their capital into it by buying and holding.

“People often have the compulsion to try to make back their money in exactly the same manner that they lost it, and there’s no rule to say they have to do that,” he said. “If we can get to a point where the Fed and other central banks start backing off on the pace of interest rate hikes, that can be very cyclically positive, in terms of a short cycle. So, equities – potentially some inflation sensitive assets –  like industrial metals and energy, should work.”

White said this is the time to de-risk equities in portfolios, but “going into Q4 and beyond, we would want to be much more tactical with some of those traditional betas, like stocks and bonds. Definitely work in diversifiers to those betas.”

He naturally favours multi-asset strategies in these circumstances and raised the importance of uncorrelated strategies at this point, particularly using alternatives to differentiate portfolios.

“There doesn’t have to be a lot of capital allocated to inflation assets,” he said, “But people could benefit from inflation sensitive assets if these shorter, faster, or more volatile cycles come about with inflation that remains sticky or hungover from this cycle.

“Then, just be wary of being the buy and hold investor,” he said, “because that only works in an era where volatility is low and volatility can only be low if interest rates are low and stable, and I don’t think that’s how the future looks.

“There are lots of things to help diversify returns away from traditional stocks and bonds. It’s up to advisors to find them and do the due diligence required because sometimes the name or category might not properly describe what it is designed to do in the portfolio,” said White. “From an advisor perspective, this new era is going to require a lot more due diligence, not just tactical thinking.”