2022: Hello Volatility

Hello and a late Happy New Year.  It has been quite a while since we have communicated our thoughts/concerns on the markets.  The reasons for that are fairly simple.  First, there is plenty of irrelevant ‘noise’ out there in the media, so we never want to fall into that category.  Second, since the onset of COVID and the market’s nasty reaction to it (March of 2020), the economy/markets have generally been humming along in good shape.

 

However, over the last two months or so, things have changed fairly quickly.  For decades, the ‘mandate’ of the Federal Reserve was to ‘control inflation’, or least that was their stated goal/primary concern.  Then the ‘tech wreck’ came along 20ish years ago, followed by the ‘Great Recession’ in 2008/09, and, of course, COVID.  Along the way, the Fed’s mission has morphed into trying to (a) control inflation, (b) keep the economy at full employment, (c) keep the stock market rising and, (d) ‘saving the world’ via extraordinary low interest rates.

 

So, officially, inflation has been VERY low over the last many years vs. historical levels.  The Fed lowered rates to 0% during the 08/09 Crisis and has essentially kept the pedal down for the last 13+ years.  These low rates have been a tremendous tailwind for the global financial markets.  Had COVID not come along one could argue the Fed would have raised rates by now and, although that process can be a little painful, a ‘normal’ interest rate environment would be welcomed by the markets over time.

 

I know we’re all very worn out from COVID/lockdown/masks/Delta/Omicron but, from a monetary standpoint, the lasting effect from the pandemic will arguably be inflation.  And not normal inflation, but once every 40 years type inflation.  It’s everywhere and we’re all dealing with it.  The US Gov’t printed Trillions to save the economy/industries/companies AND kept interest rates artificially low for longer than expected.  So, over the last 12 months, we’ve had 13ish years of inflation in one year.

 

The financial markets are adjusting in real time RAPIDLY.  The Fed controls the rate at which banks lend to each other – those rates will go up later this year.  But market interest rates – rates on government & corporate bonds – don’t wait on the Fed.  And the rate on the 10 year US Government Bond has risen from 1.2% late last summer to almost 1.9% today.  This is still very low historically, but a more than 50% rise in 4 months is a shock to the bond market.

 

In general, the stock market indexes have held up fairly well but underneath the surface there is plenty of damage.  The Russell 2000 (small cap index) peaked last February, went sideways most of 2021, and is now 15% below the November highs.  The Nasdaq is down almost 10% in 3 weeks while over 40% of the stocks in the index are down over 50%.  And the bond market?  The 1st week of this year was the worst week in the history of the US Bond market – the 30 year bond was down 9% over those first five days of January.  In fact, -9% would qualify as the worst year ever for bonds – but it happened in a week.

 

The good news is, at LJI, we don’t buy long-term bonds – we own very short-term bonds that were essentially unscathed (-1%) in the recent bond market blood bath.  We also stay extremely diversified in our core portfolios so the damage in smaller stocks and high growth stocks has only led to a 4-5% pullback in most of the major index funds.  But many individual stocks/sectors have taken a beating.

 

We are often asked ‘when is this market going to crash?’  Maybe we’re conditioned for that b/c over the last 21 years we’ve had two 50%ish pullbacks (2000-03 & ‘08/09) and one 35% drop (COVID).  But historically 3 of every 4 years give us positive returns in stocks.   Unfortunately, most focus on the fear of that one down year.  And the last 3 years has been the strongest 3 years since the late ‘90s.  So we’re due for some volatility.

 

And that expected volatility is, in general, the point of this note.  Last year, much like the post-election year of 2017, the markets generally went up.  We made no changes to our core portfolios – we just held on to our market exposure.  But markets don’t go straight up forever, and it looks like 2022 will provide us with plenty of opportunity to take advantage of volatility.  This is a good thing.  We’re generally bullish.  Rates are still very low.  This inflation scare shouldn’t last.  Corporate earnings growth is solid.  The economy is healthy.  Bank loan default rates are near all-time lows.  Most everyone who wants to work has a job.

 

Are there problems/concerns/issues?  Yes, there always are.  Washington is a mess.  Geo-political concerns (Russia/China/Iran) are ever-present.  We could go on, but we won’t.  The pullbacks in small caps, growth stocks, and whatever is coming are something we’ll look to take advantage of.

 

We would also remind you to always consider ‘What can go right from here?’.  (Remember this note “What can go Right?’ from March of 2020?)  What if the Omicron variant IS the beginning of the end of COVID?  What if the sharp rise in interest rates stalls here?  What if inflation returns to normal?  What if the 10% pullback in the Nasdaq & the 15% pullback in smaller stocks is an opportunity, like the countless market dips in years past?  Again, we’re generally bullish.

 

The last thing we’ll say is none of the above is meant to diminish the human toll many of us have experienced (and continue to) relative to COVID.  We just don’t feel this is the forum to address that aspect of the pandemic.  The whole scenario is tragic and, like you, we’re looking forward to hopefully getting past it.

 

Thank you and please never hesitate to reach out with any questions.

 

Sincerely,

 

Your LJI Team