Video Update: What Inflation in 2023 Means for Your Portfolio

Earlier today, Federal Reserve Chair Jerome Powell announced a 25-basis point interest rate hike.

That brings rates to their highest level since October 2007… but is a marked slowdown from the 50- and multiple 75-point hikes of last year.

Powell’s statements about us starting a “disinflationary process” sparked a rally on Wall Street.

But let’s not forget… Inflation isn’t gone yet. In fact, we could feel its impacts throughout all of 2023.

In today’s video update, Fortress Portfolio Chief Analyst Adam Galas walks you through all the likely possibilities surrounding inflation. And more importantly, how our portfolio is built to withstand even the worst of them.

Click below to watch your video update.

Welcome, Fortress Portfolio members, to another weekly update.

we looked at the worst-possible case scenario for inflation.

Today, we want to explain what you can actually expect from inflation and what it means for the stock market in 2023.

First, a quick reminder of the bearish case regarding China reopening so quickly. This, they have done, and the previous prediction was that oil demand would increase by 1.5 million barrels per day as a result.

We are currently waiting to see if this prediction comes true.

Because of a very tight global oil market, crude prices could climb to as high as $140 a barrel. Other commodity prices, such as copper, could also increase, resulting in inflation rising instead of falling as everyone expects.

According to analysts at UBS Group AG (UBS), in that event, the Federal Reserve might be forced to keep hiking rates far higher than anyone currently expects.

How high?

6% or possibly even higher.

Of course, that would be bad news for bonds and certainly not good news for stocks either.

That's because this would almost certainly cause a severe recession although possibly not until the second half of the year.

What that would mean for corporate earnings is that earnings would likely decline by about 20%, while currently the stock market is suggesting that earnings will go up by 4%.

Naturally, that would be bad for the equity market.

Basically, stocks could fall up to 30% from here, a peak decline of 40%.

Now, this sounds very scary for both Wall Street and Main Street. And certainly, it would be no picnic.

However, the good news is that, according to the bond market, the probability of this worst-case scenario is a lot less than 3%.

So what is the other scenario that Wall Street absolutely loves right now?

It's why the stock market is up 5% year to date.

That would be the bull case.

That is the so-called immaculate disinflation case, meaning that wage prices come down without unemployment going up significantly.

Consumers keep spending, and the economy avoids a recession. This so-called soft landing, the Federal Reserve has only managed to pull off four times in history… but never with inflation above 5%. And it peaked in 2022 at 9.1%.

So if this time really is different, then, potentially, corporate earnings might actually grow between 0% and 5%. And the stock market could finish the year up 10% to 15%.

And the bond market would also have a good year because long-term inflation expectations would be falling, driving down bond yields and, thus, the price of bonds would go up.

But of course, this is the best-case scenario.

And while slightly more likely than the bearish case scenario, it's certainly not what's most likely. So what is most likely?

Well, according to the Federal Reserve and the bond market, most likely, inflation will come down steadily over time by about 0.1% per year… Finishing the year at around 3% to 3.5%.

What that would likely mean is a mild recession because the Federal Reserve plans to hike interest rates to 5%.

The bond market suggests a slightly lower hike, 4.75%.

But either way, it slows growth enough to modestly increase unemployment above 4%.

So in that scenario, the stock market likely falls about 10% to 20% more from here, roughly 30% to a 35% peak decline.

Now, certainly, that would be frightening for most people.

It's certainly not going to be a picnic. And we might see some wild volatility.

But the most important thing for Fortress Portfolio members to remember is that short-term stock prices are vanity, cash flow is sanity, but dividends are reality.

One of our picks recently hiked its dividend 3% right on schedule and exactly as expected.

That's because we have the world's best ultra high-yield blue chips, with strong balance sheets, adaptable management teams, and strong long-term risk management.

And that's why we can sleep well at night knowing that, even if the worst case happens, we are protected, both by bonds and by managed futures. Which, last year, were literally the only things that went up.

Basically, the best hedging strategy in history combined with the best ultra high-yield blue chips in the world is how you can sleep well at night… All while enjoying a 6% yield and knowing you're on course to achieve your financial dreams.

Now, let's get to some member questions.

And I'd like to remind you to go ahead and send us any member questions you have, keeping in mind that we're not legally allowed to give individual investment advice.

But we can provide recommendations on what the market is likely to do and general investment advice for the average investor.

First up, we have Maria, who is asking whether a $10,000 investment would be sufficient and make sense for the Fortress Portfolio.

So to answer that, let's consider what might be a reasonable break-even rate, meaning how big of a portfolio do you need to make the service worth it. Well, right now, Fortress yields 6.6%. 4.4% better than a 60/40.

So assuming that you wanted to pay for the subscription only with dividends or less, you would need $34,050 in order to do that.

Now, Maria also wants to know what kind of returns can be expected in the next 5 to 10 years.

Well, in terms of growth and dividends for the next 5 years, Fortress Portfolio expects around 70%.

Now, because it's an undervalued portfolio, there's also an extra 20% returns from valuations coming back to historical norms.

That's about 90% in 5 years, or 17% annually.

Over the next 10 years, we're expecting about 180% from yield and growth. And adding that 20% valuation return, we're looking at a potential 200% return, or basically 3 times your money.

For context, the 60/40 is expected to double over the next 10 years.

So with the example of the $34,000 break-even portfolio size that we discussed earlier… Over the next 10 years, you'd make (compared to a 60/40) an extra $34,000. That is more than six times the retail cost of this service ($5,000).

Next up, we have Adam R. asking about VF Corp (VFC).

Now, he understands the deep value. It's 50% historically undervalued, a solid dividend king with a strong balance sheet.

But he's worried about the safety of the dividend and wants me to help put his mind at ease.

So this brings up two very important topics about dividend safety in general, the balance sheet and free cash flow payout ratio.

The free cash flow is simply the money left over after running the business and investing in all future growth. It's what pays dividends, funds buybacks, pays down debt, and makes acquisitions.

So the free cash flow payout ratio for this industry that's safe, according to rating agencies, is 60%.

Now, in 2023, because of the recession and VF Corp's turnaround, they're expected to have negative free cash flow. Now, that would of course be very bad and unsustainable over the long term. But that's where the power of the strong balance sheet comes in.

They went into this recession with an A credit rating. That's now come down to BBB plus, but that's still a very strong credit rating, indicating 5% chance of bankruptcy within the next 30 years.

So for this year, they might have to borrow a bit to pay that dividend. But they have plenty of borrowing capacity. More importantly, analysts expect that by 2024 the free cash flow payout ratio is going to come down to 81%, 74% in 2025, 63% in 2026, and in 2027, 67%.

That's up a bit, but that's because of an expected 13% dividend hike.

This is the kind of thing we've seen with companies like Coca-Cola (KO) and 3M (MMM). Sometimes that payout ratio gets a bit high. But that's where that strong A credit rating comes in.

So thank you for joining us for yet another video update.

Next week, we'll be covering what you need to know about what the Federal Reserve just did with interest rates, what it likely means for the economy and the stock market, and most importantly, your Fortress Portfolio for the rest of the year.

Wishing you safe investing, this is Adam Galas signing off.