Over the past several months we have written that the new economic normal means a target CPI in the 3-4% range and muted Real GDP in the 0-2% range. Interest rates can’t go back to the Volcker days as Treasury would not be able to refinance its debt at double-digit rates. We could however see the Fed Funds Rate settling at 4-5% – 100 basis points or so above the Fed’s new target CPI. Net, net, this new normal of higher prices and higher rates means valuations need to reset downward.
- The cost of capital will reset higher.
- Cash flow positive companies with modest growth that pay a dividend will become more attractive.
- Investors will once again put more focus on the fundamentals, the quality of the management team, and due diligence in general.
- This new normal will be an environment where active managers can be rewarded for their alpha-generating activities.
- The new normal will not arrive before 2024-2025.