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Time fixes a lot of things. The Bull and his partners have been through many tough markets. This has been one of the worst. We will all get through it. The backdrop is not nearly as scary as the early days of the financial crisis of 2007-2009. Then, it seemed that our entire financial system was in danger of collapsing. People were losing their homes, cars, boats, etc. More than a few declared bankruptcy. Today’s environment is nothing like that.
Today’s bear market is more of a readjustment after a period of excessive speculation. Meme stocks, SPACs, and all manner of IPO’s that had no business going public were ripe for reality checks. So too were the valuation on some growth names that may have benefited from pandemic conditions but are not able to maintain the growth momentum during more normal times. The catalyst for this correction may have been a more restrictive Federal Reserve and higher interest rates, but it was bound to happen at some point anyways.
Unfortunately, bear markets tend to pull all stocks down. Those that deserve it and some that do not. That process also provides opportunity. One just needs the optimism for a better day. Remember, bear markets are not that long-lived. 6 to 18 months is typical. This one is about seven months old. History is a good guide. If an investor bought at the top of the market in 2007 (October 9) before the financial crisis, they would still have made 9.10% per year compounded until April 30 of this year. That same investor trying to time the market and missed only the best 5 trading days, their return would have dropped to 5.71%. That is 5 out of 3,665 days. Ten days the drop would be to 3.41%, 15 the return would only be 1.51%, and 20 the results would be a loss. Being steadfast and committed to the process makes all the difference. Talk with Us.
Almost the worst first half a year since 1932. That year was at the depth of the great depression, so it’s quite a comparison. Clearly, our economy is far from that kind of contraction. So, why such an extreme reaction? It may have to do with the number of terrific return years preceding it. Or perhaps a market that got used to a great deal of Federal support through both fiscal and monetary policy. Weaning investors away from such largess has been difficult and painful. Like a drug addict trying to come clean.
To put things into perspective, we have had very good stock markets without such extreme Fed support. Also, these happened during periods of considerably higher interest rates. It will be good to get back to a period where American business operates and is valued upon its own fundamentals. We are slowly getting there. Meanwhile, taken with the perspective of the past 10 years’ returns, this really isn’t as bad as it may feel today.
Not only have stocks been pummeled, but bonds have also had nearly as big a sell-off (see the Market Indices section of this letter). This should come as no surprise. When interest rates are near zero, there isn’t much room to move except higher; and so, they have. How high might they go? It is hard to tell. So far rates have moved to levels still far below the current inflation rate. Perhaps fixed income investors believe that the economy and inflation will soon be both coming back down. We shall see. (See the Forecast section of this letter.)
It hasn’t been just the U.S. markets that have taken a drubbing. Markets all over the world have had similar reactions, a case of amazing synchronicity. In short, no place safe, no place to hide. Even cash is quickly being eroded by the inflation rate. So, what do we see now?
The U.S. economy is surely slowing. Higher interest rates along with steep price increases are having a palling effect. Remember, the cure for higher prices has been higher prices. At the margin, more and more purchasers pull back or seek alternatives. Higher interest rates most affect high ticket items that are typically purchased with borrowed money, but in time squeeze demand for most everything. After all, for most consumers, there is only so much money to go around, more spent here means less, there.
Talk of recession has become widespread. Technically, there is a possibility we may already be in one. After all, the first quarter GDP was slightly negative. However, the Lonely Bull and his partners doubt it will be all that serious of one. The downturn promises to be just as mixed as the recovery from the pandemic was, some losers, but many not that much affected. Whether this year or the next really doesn’t matter much. The stock market has already accounted for one and much worse.
Last year, Riverplace Capital Management slightly reduced the growth orientation of our various strategies. However, we maintained a bias toward growth. We have a strong belief that investing in companies that grow their revenues and consequently their earnings inevitably become more valuable over time.
However, in reaction to the Federal Reserve tightening and subsequent market correction many investors sought the relative safety of so-called value stocks. Unfortunately, those have now been bid up to levels that make them expensive. So now investors are again rotating back to growth issues. No way to make headway zigging and zagging, especially taking tax consequences into account.
We have stayed with our conviction and are seeing some initial better performance. For taxable investors, the best gains are long-term ones and even better if they continue to be unrealized and compound. As the economy slows, those growth companies that can continue to make progress will become more and more valuable. There we are, back to where things have always worked.
The fact that interest rates have risen is no surprise. The question is how much higher will they go? There is already quite a disparity between the highest quality issues and those of lesser grade. This makes sense because in a slowing economy, lower grade borrowers are perceived to be a greater risk of not being able to meet their obligations. Value is starting to emerge if inflation is peaking and will slowly recede. Good analysis is needed.
The growth style of investing is resurgent. We believe that will continue. It is how real money is made. Compounding gains year after year without having to sell because the company continues to grow is the objective.
Over a year ago, Riverplace Capital included more value-oriented stocks, but it kept a growth bias. It may be too soon to go all in on growth. Having more balance has helped during this very volatile investing environment. Some days or weeks, one style, value, or growth, was the dominant performer and the next the other. It has been more important to us that we have strong companies that we believe are managed in ways that will make them more valuable over time.
We are beginning to put more fixed income money to work in slightly longer maturity bonds. Quality is still important as we are unsure how much the economy may slow. U.S. Treasury securities are always the preferred choice. However, if there is sufficient increase in yield, other high-quality bonds are also considered.
We believe that interest rates may not go nearly as high as many strategists have been fearing. Inflation may already be or have peaked and economic slowing will do the rest of the job. Commodity price drops and other slowing economic indices are paining more positive picture for both inflation and interest rates.
We are reasonably happy with our asset allocations in this strategy. The broad diversification has weathered this volatile period well. Any further adjustments should be incremental.
as of 3/31/2022
|Large Cap Stocks (S&P 500)||-20.6%|
|Dow Jones Industrial Average||-15.3%|
|Mid Cap Stocks (S&P 400)||-20.2%|
|Small Cap Stocks (Russell 2000)||-23.9%|
|Barclay Aggregated Credit Index||-14.22%|
“Someone’s sitting in the shade today because someone planted a tree a long time ago.”
— Warren Buffet