Many investors are concerned that the chances of a global recession could hurt valuations. We must remember that investing is mainly looking to the future. So, To invest, you have to forecast. What will happen?
According to the economist Nouriel Roubini, “the recession will not be short or shallow”. In his latest book, he tells us about mega threats. Doctor Catastrophe here warns us about the high debt, the fall in productivity due to the aging of the population, climate change, geopolitical tensions, the setback of globalization, inflation, recession, stagflation and the substitution of man for machines managed with artificial intelligence, among other ills. It seems that a bleak future awaits us.
Of course, not everyone is as pessimistic as Roubini. Obviously, there are more optimistic sectors. In fact, many expect an economic slowdown that will bring inflation down to target, but without causing a recession. This scenario would be ideal. Because the negative impact on valuations would be less. Indeed, the waves of optimism that are invading the markets at the moment are based on this scenario. I refer specifically to the so-called “soft landing” (soft landing). In other words, achieve the objective without major damage.
What does this mean for cryptocurrencies? Suppose that, due to a reduction in the money supply, inflation manages to reach the target in a relatively short period of time. The demand falls. But it doesn’t cause much pain. In other words, there is no significant increase in unemployment. And income doesn’t drop that much. The economy cools, but to the right extent. If this happens in this way, that means that the central banks could return, sooner rather than later, to a flexible monetary policy. And, with the return of stimuli, the arrival of the next boom speculative. This narrative is bullish in itself. In other words, those expectations (right or wrong) generate hikes today.
It could be said that the situation of the US labor market supports the hypothesis of a soft landing. Because? Well, because, despite the policy of monetary tightening and the advances in the field of inflation, the labor market remains strong. Enough to claim victory?
of course too it is quite possible that the markets are counting the chicks before they hatch with wishful optimism. A still strong labor market exerts very significant inflationary pressures. Which complicates the fight against inflation quite a bit. Because this inflationary problem does not only come from the demand side. There are also inflationary pressures coming from the supply side. Any failure in the production and distribution chains can cause a setback with monetary consequences. Unfortunately, many things can go wrong. And usually, when many things can go wrong, something does. Am I exaggerating?
Investors are betting on the best case scenario. However, at such a complex timethe best scenario is not guaranteed. In times of volatility and uncertainty, the most sensible thing to do is to hope for the best, but prepare for the worst. That means not putting all your eggs in one basket. And it means that we must have excellent risk management. The big mistake is to fall into a naive and deluded optimism. In the investment world, the careless is the one who loses the most.
Now, the valuations of a company are normally based on its income. Of course income is important. But even more important are the projections of future income. The investor buys today thinking about today’s valuations in relation to tomorrow’s valuations. So the possibility of a recession in the future naturally has an impact on valuations today. New information arrives every day. AND every day narratives are built based on the information obtained. Optimism generates purchases. Pessimism generates sales. Markets fluctuate to the rhythm of different expectations. The problem is that the future is not written and the possibilities are many. Thus, markets fluctuate as interpretations of the situation fluctuate.
Now, inflation is a multifactorial phenomenon. Monetary is not everything. So in this field, central banks are not omnipotent. Of course a soft landing is a possibility. But everything will depend on inflation. If inflation refuses to reach the target soon, the Federal Reserve will be forced to continue its monetary tightening policy with greater intensity. Demand would have to fall further. However, it would be a much more painful process than anticipated by the most optimistic. The optimistic forecasts are based on the fact that inflation is coming down and the Fed will not have to raise rates much above 5%. If this proves not to be true, pessimism could invade the market. And consequently, valuations of risky assets (such as Bitcoin) could suffer significant losses.
What do I think? Will a recession come? Actually, I do not know. I think it’s quite likely due to the complexity of the situation. Too many things must go well for that long-awaited soft landing be achieved. And my skeptical nature pushes me a bit towards pessimism. However, I know that the possibility is on the table. Personally, I am inclined to believe that the market is betting on a false expectation at this point.
As an investor, in my opinion, the most sensible option is to design a mixed strategy. In other words, we can gradually buy variable income assets that we consider to be at a discount. But at the same time maintaining a diversified and balanced portfolio of great stability. Let’s say we are earning income from fixed income instruments and we use part of this income to make dollar-cost averaging (see dollar-cost averaging) in crypto. In this way, we gain exposure, but without assuming much risk.
The great challenge is to overcome uncertainty. And uncertainty can be reduced with planning and strategy. In general terms, the recession is being fought with stability. In other words, it is advisable to add predictability with liquidity and stability (cash, fixed income…) Unemployment? Low sales? Little income? Business opportunities? Family emergencies? There is not much problem, because the relevant measures were taken in advance. In conclusion, as investors, we are not always correct in our forecasts. However, for long-term success as investors, always have a plan in case our forecasts fail. In this case, we must design a strategy where we come out well in the different scenarios. Recession? Good. Not recession? Fine too.
Disclaimer: The information and/or opinions expressed in this article do not necessarily represent the views or editorial line of Cointelegraph. The information presented here should not be taken as financial advice or investment recommendation. All investment and commercial movement involve risks and it is the responsibility of each person to do their due research before making an investment decision.
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