Chaos

Four months into the year and the stock market is down over 13%, as measured by the S&P 500.  Historically speaking, this is one of the worst starts to the year we’ve experienced since the 1940’s; the market is resonating a multitude of challenging economic conditions and difficult geopolitical news from across the globe.  For a long time the market seemed content to look past all the bad news but now, to the chagrin of many investors, it is finally behaving in accord with the tenor of the news flow.

              When markets are behaving in this fashion, it is extremely difficult to detect tradeable patterns or effectively utilize factors to hone in on what’s working – or even what’s doing less bad.  The sectors under the most pressure are technology, communications and consumer discretionary (Apple, Google and Amazon) while the best performing sectors are energy, utilities and consumer staples (Chevron, Exelon, and Kellogg).  Stylistically, value stocks have fared much better than growth and stocks with dividends behaved better.  The bond market has been a disaster with the US 10-year treasury ETF (IEF) down over 10%.  Apart from commodities and fossil fuels, there has been no place to avoid falling prices.

              In my opinion, the overriding concern for investors is rising interest rates.  In an effort to push back against high levels of inflation, the Federal Reserve is utilizing monetary policy, and raising short term interest rates in an effort to force businesses and consumers to reduce spending.  Higher borrowing costs will ultimately slow economic growth and thus reduce inflation.  Corporate growth may be restrained and profit margins reined in, which could ultimately lead to lower earnings and stock prices.

              Other obvious concerns are the war in Ukraine, the disruption to energy and food prices, and the potential for this to bleed into the substantial economies of Western Europe.  China, the second largest economy in the world, is deploying a policy of zero-COVID, threatening China’s basic economic health, and perpetuating supply chain issues which have only just begun to heal.  There remain undefined systemic issues that could well arise from the banking system relating to the not widely understood financing of the global commodities trade.  All represent undetermined and likely long-duration issues for the markets. 

              We are watching for signs in the US of marginal improvement in conditions favorable to the stock market.  For example, certain measures of inflation look to have peaked and with higher interest rates, mortgage applications look to have crested.  Measures of consumer sentiment, a widely followed leading indicator, are low; this points to the likelihood of a deceleration already underway.  Evidence of an organic slowdown is helpful as such a deceleration would allow the Federal Reserve to scale back its monetary tightening intentions. A lower growth backdrop is also often constructive for large cap US growth stocks.

              Barring something more systemic, I think the phase the market is in will not become notably worse.  We may be relieved at year-end to have break even returns – after several robust years, simply not losing money may be enough.  I think it will take time for this to bear out and the increased volatility in prices could make being patient a challenge.  While stocks may have been overpriced in December, they are no longer – valuation spreads are back to their long term averages.  Of course, prices may move lower as earnings estimates are revised down to reflect decelerating growth rates.

              In my opinion, during periods like this, it is impossible to make any sense of the day-to-day moves in stock prices.   Any near-term prognostications are simply guesses.  For us, as long-term investors, we have pushed through difficult times like this before.  At some point still unannounced, the market will right itself and we will be back to a playing field where we can make informed decisions on investments to buy or sell and trust our analysis to bear fruit.  Until that point, we must be more measured, hold high quality stocks and higher levels of cash than would normally be justified.

              Please do not hesitate to call if you have questions or would like to review your portfolio.  We are here when you need us.

Bruce Hotaling, CFA

Managing Partner