Vladimir Putin’s decision to invade Ukraine is a test to the western ideology most of us identify with. It seems like a childish attempt to see how much he can get away with, and at what cost. The invasion of another country is cruel and intolerable; these are people, not avatars. A country and its economy, industry and cultural history is purposefully being destroyed, for no reason. The war echoes the famine Russia created in Ukraine in the 1930s with ostensibly similar political motives.
It’s not just the immediate outcome but also the extended fallout from the war which is unclear. Certainly food and energy prices will be effected for the foreseeable future, particularly in Europe. Other commodities and metals have also been compromised directly, through broken supply chains, or indirectly, through sanctions and other political implications. There are concerns that there may be a more disruptive financial crisis looming with the large banks providing credit for the commodities business with Russia.
Amidst all this, the US stock market is making a gallant effort to sort itself out. Having fallen at a harrowing rate the first two months of the year, it seemingly found its feet on March 14th. All of a sudden, the tone of the market changed. Prices (S&P500) closed at 4,173 that day, and by March 31st had risen 8.5%. This left the market with a return of 3.6% for March, reducing the year-to-date loss to 4.6% and bringing prices back above the 50- and 200-day moving averages enough to allow the market’s technical analysts a nice deep breath.
Looking back, the market has also been attempting to digest the imminence of higher interest rates, the magnitude of which cannot be overstated. Interest rates (the US 10-year Treasury) have been falling for roughly 40 years. In August 1981 the US 10-year yielded over 15% and in August 2021 it yielded a smidge over 1%. Today, it’s more than doubled to 2.3%. On the shorter end, the yield on the US 2-year note has jumped 1.6% in Q1, the largest jump since 1984. The point is the market has been working hard to price in the Federal Reserve’s tightening campaign and it looks like the bulk of this has been priced into stocks.
There is some optimism looking forward, with spring approaching and data on the virus continuing to improve. The employment numbers are improving: people have jobs, are earning better wages and the labor supply remains constrained (boomers retiring and effects of COVID). Inflation will diminish as the supply chain snags and energy prices sort out. In my opinion, this is largely a matter of time. One concern is the Federal Reserve potentially acting too strongly in raising rates, as the war and a tendency toward de-globalization may more naturally slow growth and bring inflation down with it.
Stocks are better valued now with the P/E ratio on the S&P 500 having dropped roughly 20%, and the P/S ratio now in the 2.5x range, which is historically a reasonable level. Year-end earnings targets remain in the $240-a-share range for the S&P 500. At an opportunistic 20x forward P/E multiple the year-end price target for the S&P 500 would be in the 4,900 range, roughly 10% higher than today’s level.
We are focusing on stocks that are not likely to face a disruption in their future earnings outlook from the primary constraints we see: higher input costs including energy, a more reluctant consumer as confidence is low, and continued supply chain constraints (though the microchip sector appears to be normalizing). We are reviewing stocks in several sectors, including real estate, health care and technology. I think quality stocks remain the best house on the block. We are also finding more attractive fixed income, at these improved yield levels, for the first time in several years.
Please do not hesitate to call if you have questions or would like to review your portfolio. It is also tax time, so please let us know if we can be helpful in that regard. We are here when you need us, and in these tumultuous times, that can be more often than not.
Please be safe out there.
Bruce Hotaling, CFA
The views and opinions stated herein are those of Bruce Hotaling, are as of this date, and are subject to change without notice. Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed. Investments are subject to market risk, including the possibility of loss of principal. Past performance does not guarantee future results. The S&P 500 is an unmanaged index of 500 widely held stocks. Investors cannot invest directly in an index. The PE ratio (price/earnings) is a common measure of relative stock valuation. This note contains forward-looking statements, predictions and forecasts (“forward-looking statements”) concerning our beliefs and opinions in respect of the future. Forward-looking statements necessarily involve risks and uncertainties, and undue reliance should not be placed on them. There can be no assurance that forward-looking statements will prove to be accurate, and actual results and future events could differ materially from those anticipated in such statements.