Our belief is that the equity market most likely reached a cyclical peak in January 2022 due to historic levels of overvaluation, extremely bullish investor sentiment and positioning, and the acceleration in inflation that brought about the most aggressive Fed tightening cycle in the past 40 years.

The rally in equity markets from October of last year through July of this year coincided with falling inflation, hopes of a timely reversal of Fed policy, and economic data that turned out to be more resilient than was generally anticipated. The rally was more powerful and longer lasting than we expected given the compelling alternative that fixed income securities provide today. If there is no economic hard landing, there is little reason for the Fed to reverse the rate increases of the past year, leaving fixed income yields quite attractive relative to the dividend and earnings yields generated by equities at today’s prices. If there is a recession, earnings and equity prices should materially decline due to the contracting economy.

Aggressive Fed tightening cycles of this magnitude have produced a recession in every instance in the post-war period, although it often takes a year or more for the change in monetary policy to fully affect economic conditions. We have yet to experience the full effect of the Fed’s tightening cycle.

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