Five Questions for Long-Term Investors (with Answers)

The path of inflation and Federal Reserve policy, the chances of a “firm, gentle, or no decline” for the U.S. economy, and the consequences of the Fitch Ratings downgrade of U.S. debt are some of the factors influencing market sentiment. While short-term developments are undoubtedly crucial for the 2023 market direction, most investors have a longer-term perspective, measuring their horizon in years rather than weeks or months. Investors should concentrate on the enduring consequences of recent events, resisting the urge to overreact to immediate news. Answers to these five questions will provide valuable insights for long-term investors:

1) Can inflation reach the Fed’s 2% target and stay there sustainably?

While inflation is approaching the Fed’s target, 2% may become the new baseline for inflation rather than the ceiling. Factors like deglobalization, fiscal deficits, climate change, and demographics with inflationary implications create a more unpredictable inflation environment. After a decade of central banks striving to raise inflation to the 2% target, the next decade may see central banks worrying about inflation surpassing the target. Consequently, both the lows and highs in bond yields are expected to gradually rise. Given that inflation is a more persistent concern than deflation, bonds will offer a less reliable hedge against declining equity values. Long-term investors concerned about inflation should consider adding investments that are resistant to inflation, such as real estate investment trusts (REITs), tangible assets, infrastructure, and Treasury Inflation-Protected Securities (TIPS).

2) What are the investment consequences of the transition to a green economy?

The transition to a green economy will create both opportunities and challenges for investors. Weak conventional oil capital spending will lead to volatility in fossil fuel prices, with periodic supply shortages causing price spikes. Refinery capacity may become a concern, resulting in further supply constraints. While alternative energy capital spending will be robust, it’s unlikely that alternative energy sources will scale up quickly enough to meet current climate goals. Duplicative supply may be required for longer than anticipated to complete the energy transition. Investors should consider investments in both traditional and alternative energy, recognizing the likelihood of a prolonged and costly transition. “Enablers” that support the transition, such as natural resources and companies enhancing production efficiency, may also be attractive investments.

3) What are the implications of the Fitch downgrade for bond markets?

Although the Fitch credit downgrade coincided with increased Treasury selling, previous downgrades of major-country debt have had only temporary effects on yields. Recent yield increases are primarily driven by rising Treasury issuance, growing government debt, and deficit spending. In contrast to the corporate and household sectors, the U.S. government did not extend debt maturities when interest rates were low. The need to refinance government debt at higher rates will strain the U.S. budget and is likely to keep rates from returning to post-global financial crisis (GFC) lows. With bonds still offering modest yields relative to inflation, income-focused investors may need to diversify their traditional bond holdings in the quest for yield.

4) How does the outlook appear beyond the U.S. borders?

European and Chinese equities remain attractively valued after more than a decade of mostly trailing U.S. equities’ performance. Europe faces short-term challenges due to weak demand from China and ongoing adaptation following the loss of cheap gas imports from Russia. However, in the long term, the end of fiscal restraint and adjustments to the changing geopolitical landscape will create intriguing investment opportunities. Rising defense spending, the need for industrial efficiency, and energy security in a world of higher prices and less dependable natural gas sources will present investment prospects for European industrial firms. European banks may also become more appealing in a low negative interest rate environment. Despite near-term obstacles, there are also compelling investment prospects in China. Market leadership in China is expected to shift, with industries like semiconductors, artificial intelligence (AI), healthcare, and electric vehicle infrastructure taking precedence over the social media leaders of the post-GFC era.

5) Will artificial intelligence (AI) fulfill recent hype?

The excitement surrounding AI has boosted returns for companies perceived to be at the forefront of AI development and adoption. AI has the potential to be a transformative technology, but investors should be realistic about the timeline for realizing its growth potential. There is typically a considerable gap between technological progress and the commercialization of innovative ideas. Even if AI lives up to its transformative potential, it may be several years before it significantly enhances productivity. There are various ways to invest in AI. Companies enabling AI development, including major cloud providers and semiconductor manufacturers, will benefit from AI adoption. Cybersecurity will become increasingly vital as AI becomes ubiquitous. Industry adoption will also create opportunities for companies effectively deploying AI. Wealth management, insurance underwriting, and power grid management are among the sectors exploring greater AI utilization to enhance productivity. As is common with disruptive technologies, today’s leaders may not necessarily be tomorrow’s winners. Some established businesses will benefit from incorporating AI, while others will face a wholly new competitive landscape. Investments in securities carry inherent risks and may result in income and/or principal loss. This communication may contain opinions and forward-looking statements. All statements, other than historical facts, are opinions and/or forward-looking statements (including words like “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). While we believe these beliefs and expectations to be reasonable, we cannot guarantee their accuracy. Get back to Seikum News 🤓

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