Greetings & Happy Spring. We trust this note finds you well.
In late January we sent out a note (Hello Volatility) discussing the financial markets going through a rough January and the Federal Reserve navigating this economy with 40-year high inflation. As we take inventory of the global markets three months later, the trends of January continue. Interest rates continue to climb, inflation has gotten worse, and stocks have reacted accordingly.
In fact, thru the end of April, the S&P500 has had the worst start to a year in over 80 years. The bond market is having its worst year EVER, by a long shot. This is the worst start ever (-21%) for the Nasdaq Index, going back to 1971. The US Small Cap index is also down over 20% from the November highs, and the overseas markets have taken a beating as well.
Typically, when the equity markets decline, the bond markets rally. That is generally why we own bonds over time. However, this year, for the 2nd time ever, both the stock and bond markets are down over 10% at the same time. There really has been nowhere to hide.
Why? The global markets are currently trying to digest & discount:
- 40-year high inflation
- $100+ oil
- Supply chain issues
- A Labor crisis
- A historic spike in interest rates
- The lingering threat of COVID
- The conflict in Ukraine/Russia
Any ONE of those issues is enough to roil the financial markets. The confluence of all seven brings us to a brutal first four months of 2022. One could easily argue the global pandemic is the cause for 1-5 above. And the Russia/Ukraine scenario exacerbates everything. Markets despise uncertainty and, as things stand today, there is most definitely mass uncertainty.
Where do we go from here? Well, like most of you, we expected COVID to be in our rearview mirror 26 months from its onset. Unfortunately, that isn’t the case. However, it seems the worst is behind us health-wise. And, while COVID is annoying & tiresome (to put it mildly), in the big picture COVID is likely ‘temporary’. It will go away at some point – or morph into the flu.
We believe, like 40ish years ago, inflation is temporary (albeit PAINFUL) and has likely peaked. Oil is cyclical – always has been and likely always will be. The supply chain issues seem to be unwinding, depending on the industry. The labor crisis will likely work itself out as well, whether we get more automation or more people ‘getting off the couch’. The spike in interest rates has taken the 10-year treasury rate up to 3% – back to where it was in 2018. Again, COVID has not gone away but it certainly feels like we’re headed in the right direction
Ukraine/Russia? That’s a tough one. The human toll has been terrible, unnecessary, and very sad. The global energy markets have been chaotic. There is much uncertainty in Europe relative to energy supply/solutions. The threat of food shortages is very real. However, IF we avoid WWIII, a nuclear threat, and the conflict is generally contained – big IFs, we know – longer-term, there are positives.
What if Russia is proven to no longer be a ‘Superpower’? Is Europe better off not relying on Russia for energy? If things do escalate, considering the collective cooperation (so far) on the economic front, does a drawn-out war seem likely?
A lot to digest. Much uncertainty. There is a lot of ‘bad’ factored into the current markets. Could things get worse? Sure, that’s always a possibility. But we’ve been here before. Markets don’t go straight up. Momentum works in both directions and, right now, the downside momentum is extreme. And that is reflected in prices. The only way to lock in, or guarantee, current paper losses is to sell and accept current prices. We believe that would be a major mistake.
Most every metric of market sentiment (Fear vs. Greed) available is showing significant FEAR right now – in many cases, comparable to the tech wreck and the Great Recession (2008/09). Like then, selling into that fear was devasting to future market returns and achieving financial goals.
Warren Buffett is known for many sayings – his most important, arguably, is ‘Be greedy when others are fearful’. We wholeheartedly agree. With prices LOW, we’re optimistic and we’ll look to take advantage of these lower prices.
For the record, it is ok to be scared at times. But ‘scared’ is not an investment strategy and shouldn’t guide portfolio decisions. Emotions drive MOST of the volatility in the financial markets. The key, long-term, is to recognize and take advantage of the emotional extremes when they arise.
Speaking of scared, should we be scared of a recession? In a word, no. They happen. Recessions are part of the economic cycle. The greatest gains in the stock market are typically made coming out of downturns. That is simple history. That is why it is so important to not let market volatility wear you out.
Are we going to have a recession this year? We believe that is likely. Why? A recession, by definition, is when the economy shrinks for two quarters in a row. The 4th quarter of 2021 brought US GDP growth of 6.9%. That is phenomenal growth. What happened during the 1st quarter of 2022? Our economy shrunk by 1.4%. That seems natural/normal to us after such a strong Q4. We’re already ‘halfway’ thru the definition of a recession. All things considered we wouldn’t be surprised if went slightly backwards again this quarter.
It is important to remember that not every recession leads to devastating times. Markets overshoot. Fear can win in the short-term. That typically provides opportunities. Capitalism wins over time – always has.
Despite shrinking in Q122, the US economy is still running fairly hot. COVID has brought supply chain issues, but those issues wouldn’t persist without very strong demand. The housing market is on fire. We currently have 5.6M more job openings than unemployed humans in the US. This doesn’t exactly point to doom & gloom on the horizon.
We’ll stop there. Again, 2022 has been brutal so far – that’s undeniable. But that doesn’t mean the market cannot recover. There are many issues out there – we all know that. Most will be resolved in time, hopefully quickly. If it takes 3 years for the Nasdaq & the Small Cap Indexes to return to where they were just 6ish months ago, they’ll average roughly 9% over those 3 years. Fear is rampant but history is undefeated. We’re optimistic.
Finally, should you wish to review them, during the height of the COVID volatility we sent out a number of newsletters – a total of six between February 28th and April 3rd. Those notes can be found in the newsletters section of our website. We encourage clients to review these as many insights/lessons/rules are as applicable today as they were in 2020.
Thank you and please reach out at any time with questions &/or concerns.
Sincerely,
Your LJI Team