Is the “Goldilocks” scenario about to be mauled by the 3 economic bears?

Investors, akin to our dear Goldilocks, are navigating the marketplace, sampling strategies as one might different bowls of porridge. They're trying to find the financial formula that's "juuuust right." Having believed they've struck the right chord, they're reclining basking in temporary contentment wholly unaware of the approaching rumbles.

Enter the three economic bears, not merely annoyed about their disrupted breakfasts but emblematic of towering market challenges. Individually, they’re each a force to be reckoned with. Collectively, they're the ultimate trifecta you don’t want to mess with.

The Papa Bear is definitely Bond Yields

Papa Bear, known to the financial world as Bond Yields, has been restless of late. Those deep growls you hear? That's the US10Y marking a staggering 16-year high. This isn't just a random forest rumble. This growl is deeply rooted in some very real, very concerning developments. The underlying culprits causing Papa Bear's agitation? Stubborn inflation combined with an ever-increasing glut of issuance, both spiraling into a more significant government debt issue.

Minutes from the US Federal Reserve’s July meeting have illustrated divisions over further rate hikes, resulting in surging Treasury yields—a trend that's setting the mood for European bond markets. In the face of robust economic data, investors are becoming more confident that the Fed will maintain these elevated rates for an extended period. The yield on the 10-year US Treasury Inflation-Protected Securities (TIPS) striking a rate of 1.998%, the loftiest since 2009, further affirms the global expectation of sustained tight policies.

Our Mamma Bear is China

As 2023 dawned, Mamma Bear, emblematic of China's economy, was expected to shake off her slumber post-COVID-19, rejuvenated by fiscal stimuli. Yet, she found herself entangled in persistent challenges: demand, debt, and demographics.

Amidst the forest murmurs, the name Evergrande once a towering giant in China's property landscape, Evergrande's bankruptcy in New York rang alarm bells. And just when the market was absorbing this shock, another prominent developer, Country Garden, teetered dangerously close to the edge. For those needing perspective, Country Garden's current projects dwarf Evergrande's situation from last September by fourfold. Remember the tremors felt globally when stock markets plummeted over 12%? We're talking about a potential tremor of that magnitude, maybe more.

Hints of structural cracks appear everywhere: disappointing retail numbers, a surge in unemployment, and even the PBoC’s surprise move to slash its benchmark interest rate, the biggest cut since 2020. The hope was to jolt the sluggish beast awake, but Mamma Bear seems to need more than just a nudge to regain her formidable stride.

And…the baby bear is AI stock Valuations

AI stock valuations, epitomized by the "baby bear," witnessed an unprecedented rally led by the "magnificent 7," amassing nearly $4T in market cap. Behind this surge, however, lurks OpenAI's daunting financial challenges. The AI pioneer, known for ChatGPT, spends an eye-watering $700,000 daily on the service. Despite its revolutionary potential, revenues fall short of its massive operational costs. ChatGPT's user base has declined, with competitors like the free LLaMA 2 posing threats.

Internal rifts, marked by CEO Sam Altman's ethical concerns over AI's unchecked growth, add complexity. Losses since ChatGPT's inception are staggering at $540 million, making OpenAI's ambitious revenue projections seem lofty. An IPO might be the saving grace, but issues like high attrition rates and fierce competition, especially from visionaries like Musk's forthcoming "TruthGPT," pose significant barriers.

If history has taught us anything, it seems very hopeful that the Goldilocks scenario will play out and this won't end well for those investors currently enjoying a nap in the baby bear's bed. 

So how does Goldilocks escape?

Allocate some of your portfolio to fixed income - the good thing about high bond yields is exactly that, high yields! Switching some of your portfolio to fixed income for a period will hardly hurt your returns as Banking Hybrid ETFs like Betashares Australian Major Bank Hybrids (ASX: BHYB) and Global X US Dollar High Yield (ASX: USHY) both yield over 7% (BHYB after franking credits) which isn't far off the average annual return of the equity market and easily switched back into equities when you feel the market has bottomed

Take some profits - it's been an unexpectedly good H1 of 2023, lightening the load in times of uncertainty is never a bad idea in uncertain times, not to mention good for your mental health!

For those who don't want to realise capital gains, buy a hedge like Betashares Australian Strong Bear Hedge Fund (ASX: BBOZ) and Betashares' US equivalent (ASX: BBUS) are good tools to reduce risk in your portfolio, but just remember, the length of bear market periods is a third of bull markets, the hedge is meant for short term cover, not long-term.

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