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People are people. Their behaviors never really change. Read history, or better yet, Shakespeare, and the same impulses, motivations, and reactions occur over and over again. Fear and greed play a yin and yang roll in any period. Therefore, good investors can predict panic and exuberance from one period to the next. It is also why being a contrarian and going against the grain of sentiment works so well. The adage is to buy when others are fearful and sell into exuberance.
The stock market is partially a mechanism that values the fundamentals of a business, but it also has a psychological component to it. After all, it is an institution made up of people. Sometimes the fundamental aspect outweighs the emotional one, and at other times, it is the opposite. We have all seen markets driven by momentum, meme stocks with little in fundamentals getting a big play, and then there are the times that profitability means everything. One thing you can count on is that herd instincts are always close by.
Presently, investors are fixated with inflation and higher interest rates, along with what they may do to economic growth. The word recession is not very far from many lips. In fact, sentiment has been so negative that the stock market has probably priced in much worse than is likely. This leaves opportunity to pick up some bargains, buying when others are fearful. One, however, must have the appropriate time horizon, recognizing that recovery may take time.
Some of the best investors are part psychologists as well as good financial technicians. After all, markets are made up of people, and people are people! Talk with Us.
A lot of rain–that is what we got in 2022. The stock market correction came well in advance of any economic decline. There is still a debate as to the style and magnitude of any slowdown. So far, except for the inventory correction in the first half of this year, we are not yet seeing anything serious. Certainly, there is anecdotal evidence of slowing in certain sectors, but nothing that corresponds to a general decline, just a mixed picture.
The stock market was pummeled into an interim low in June then recovered some, only to return and make a new low in October. Except for energy, there was no place unaffected. Growth stocks took the brunt of the selling. Many of these were highly valued, had been big winners for many years, and presented big profits to be taken by investors wanting to scale back their exposures. Also, investors calculated that with higher interest rates, stock multiples should come down. So, growth stocks were down the most.
Bonds values also came down. To rein in inflation, the Fed set about raising rates. Starting from zero, there was only one way to go anyways. (Remember, when rates rise, bond prices decline.) So, stocks and bonds declined at the same time! Again, precious little place to hide.
Negativity has been pervasive. What has been in short supply is the recognition
that corrections are a normal part of investing. They address excesses and bring expectations back down to earth. They also often go too far and can provide opportunities. Sorting through to find the real values is what we at Riverplace Capital do. See what we see coming in the Forecast section of this letter.
Recession: yes, or no? That is the question investors have been grappling with all year long. There was an inventory correction for the first half of 2022. Too many companies over ordered in response to the supply issues during the pandemic, then suddenly had too much. By now those excesses have been worked off. Now, investors fear that to bring inflation down, the Federal Reserve will have to raise rates to a level that sinks the economy. They can also point to several past examples of the Fed going too far.
Recently, investor sentiment has vacillated between hopes for a mild downturn and fears of something much worse. Every bout of optimism is ultimately met with selling as investors wait to make serious commitments. At Riverplace Capital Management, we believe that a soft landing is still possible. There is still great economic momentum, consumers have jobs and savings and seem willing to spend. The Inflation Reduction Act as well as the Infrastructure Bill continue to put government money into this economy.
Is a recession possible, certainly, but not a given. There seems to be more fear of than evidence of one until now. The course of inflation will determine how much more tightening is needed. So far, inflation appears to have peaked and is trending down. We are keeping our fingers crossed that too much more medicine will not be needed.
Stock markets bottom and begin anticipating recovery well before the economy does. The anticipation can be 6 to 9 months in advance. Bear markets, historically, have lasted between 6 and 18 months. With hindsight, we can determine that this one started in November of 2021. So, it is already well past the mid-point of the average duration.
The question should really be, “how much is a recession already priced into current stock prices?” Actually, at least a mild one is clearly anticipated.
It is now time to begin preparing for a new bull market. The start of one will be met with skepticism, disbelief, and negative responses; it always has. We may have already begun recovery. Time will tell, but we are not far off starting a recovery, if history is any guide.
The equilibrium level of interest rates has probably not yet been achieved. Riverplace Capital Management expects inflation to eventually to settle out around 3 percent. That implies a long-term interest rate much higher than those of today. Today’s low rates are responding to fear. Money has been seeking a haven during the bear market and responding to an unsettled geopolitical environment.
Short-term interest rates are being set by the Federal Reserve to be restrictive. Eventually, short-term rates will need to decline, and long-term ones rise. The process toward a new equilibrium will be able to begin once the Fed stops raising interest rates.
Except for tax loss harvesting, Riverplace Capital Management has been holding the line on its stock positions. Stocks sold to recognize losses will soon be replaced. There may even be a few new positions added as well. In the Forecast section of this letter, we announce that Riverplace Capital believes the stock market has or soon will bottom. Now is the time to position for that eventuality.
Growth as an investment style will come back once investors get off recession watch. Growing companies always have great worth and in what may be a subdued economy, these will again sell at a premium. Remember, we have had good stock markets with much higher interest rates. We will again.
One-to-three-year treasuries or CDs are our preference for fixed income investments. We get higher yields and flexibility to reinvest at higher rates later, as longer rates move up. There will be a time to purchase bonds with longer maturities; this is not it.
For income needs, Riverplace Capital has preferred using a high-dividend stock approach. This strategy has worked very well and produced excellent income and positive performance during this difficult market environment. However, for those that need to invest in bonds, it is finally a much better time.
The broadly diversified strategy of our asset allocation model has worked well during this period of heightened volatility. After the allocation adjustments we made last year, we are pleased with the results of this strategy. Our timely allocations to mid and small caps worked especially well. No further changes are contemplated.
as of 3/31/2022
|Large Cap Stocks (S&P 500)||-19.6%|
|Dow Jones Industrial Average||-8.8%|
|Mid Cap Stocks (S&P 400)||-14.5%|
|Small Cap Stocks (Russell 2000)||-21.6%|
|Barclay Aggregated Credit Index||-15.71%|
“The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.”
— Warren Buffet