Archived Mail
Archived Client Emails
January 4, 2022
Greetings,
Happy New Year! I hope you and your family had a wonderful holiday season. I wanted to give a recap of 2022 and discuss our outlook for 2023.
2022 was a rough year for the global markets and I have been looking forward to turning the page on 2022 since June! What areas of the markets worked in 2022? Energy and Utility stocks. The Energy sector (oil and gas companies) was up over 60%. What didn’t work? Just about everything else. Stocks, as measured by the S&P 500, were down 18.11% with Large Growth Companies (companies like Amazon, Apple, Microsoft, Netflix, Google, etc.) down over 30%. The U.S. Aggregate Bond Index finished down 13.01%, the worst year on record. The benchmark 60/40 “balanced portfolio” according to Morningstar, was down 14%, one of the worst years on record. The reason for the market carnage? Inflation and the Federal Reserve. Quite frankly, the Federal Reserve was completely wrong with their inflation and interest rate forecasts a year ago. In the September 2021 meeting, we were told that inflation was “transitory” and would likely normalize in the spring of 2022 as supply chain issues returned to normal. They also said there would be NO rate hikes in 2022. At their December 2021 meeting, the FED forecasted only three rate hikes totaling .75% in 2022 as inflation appeared a little more “sticky” than they thought a few months earlier. The FED then went on one of the most aggressive rate hike campaigns in history taking the FED funds rate all way to 4.25% from 0%. What frustrates me the most is that this likely could have been avoided if they had followed the real-time data back in 2021. Inflation was evident and quickly moving higher in early 2021 as we started to reopen the economy. The economy was hitting historic growth rates as well in 2021. There was no need for zero interest rate policy in 2021, nor was there a continued need for massive stimulus spending. The FED should have started a modest rate hike campaign in early 2021 when the evidence of inflation was building. This would have completely taken the “shock” out of the markets in 2022.
What did I get right in 2022 with regards to portfolio management? If you recall my Outlook for 2022, I thought we would see heightened volatility with a likely market correction of 10% - 15%. I said the major risk was inflation and the FED. I was underweight stocks vs benchmark models in early 2022. I was also underweight bonds and decreased allocations to long term bonds in favor of short-term bonds in the summer of 2022. That proved to be the right call. What did I get wrong? As the markets went down 15%, I started adding to stocks. I took an overweight position in Large Growth companies relative to Large Value companies when the Large Growth index was down about 20% in late spring. I added to Large Growth and Value stocks again during the summer, moving to a slight overweight position vs the benchmarks. I did not anticipate the overall markets going down another 10% and Large Growth companies going down another 15%. I thought we would see a rally in the 4th quarter as the data was clearly pointing to a slowdown in the economy and inflation rolling over. The rally started to pan out in October and November as the markets rallied roughly 12% on positive inflation reports and lower market interest rates. FED Chairman Powell quickly brought the party to an end at the FED’s December meeting with continued tough talk on inflation and rates, taking the market down roughly 6% in December. My fear for 2023 is that the FED ignores the data once again and continues to move rates higher than what is already expected.
What can we expect in 2023? I think the odds of a FED-induced recession now stand at 50/50. Per my previous emails, according to CNBC, the average market decline in a recession is about 32%. The average stock in the S&P 500 is already down about 35%. Thus, I don’t see the markets getting a lot worse than what we have already been through. The markets could easily trade down to the October lows or even a bit lower but unless there is another “shoe to drop”, I don’t see the declines getting much worse than that. I think the first quarter of the year, in particular, will be volatile as we have another FED meeting on February 1st and fourth quarter corporate earnings reports and outlooks start to roll in as well. As I said earlier, the biggest risk in my opinion is a FED that misses the ball (again) on inflation and continues hiking rates beyond expectations, which currently stands at a FED funds rate of 5%. The silver lining of a recession caused by the FED’s interest rate policy is they can reverse course and begin cutting rates to stimulate growth just as fast as they slowed economic growth with rate hikes. It is very important to note that the markets tend to move well in advance of an actual economic turnaround and also tend to move higher a full year before corporate earnings bottom out, this according to Tom Lee at Fundstrat. For the markets to begin to rally, we just need to hear from the FED that they are near the end of their rate hike cycle, which they are likely to be. The biggest sticking point for inflation this past year has been housing and rents, which is now starting to rollover as well. Commodity prices have come down significantly as well as shipping rates. Wage growth is also starting to show signs of slowing, which is all positive for inflation and, hopefully, the FED is paying attention this time. LPL Research has their fair value estimate for the S&P 500 at 4400 – 4500 by year end which marks a gain of roughly 16% from current levels. The aforementioned Tom Lee set his target at 4750, or a gain of over 20%. Believe me, there are also many bearish analysts on Wall Street with predictions of the S&P trading down to the low 3000’s with corporate earnings collapsing. The consensus is an awful first half of the year with the economy falling into a recession and then moving higher in the second half to finish roughly flat.
Entering 2023, my portfolio models are slightly overweight stocks relative to bonds and still overweight cash. I have recently increased exposure to bonds in some models and I am still slightly overweight Large Growth stocks relative to Large Value as I believe long term economic fundamentals and consumer behaviors favor that category. I am always looking for opportunities to deploy cash and if we see continued weakness in stocks or if interest rates spike again, I will be adding to both stock and bond positions. If you have been paying attention to my emails, you know that I am most optimistic when others are pessimistic…most of the strategists and asset managers on Wall Street are very pessimistic! I am not an economist, but I have almost 30 years of market experience. Experience tells me any time you can own quality companies with strong cash flows, strong balance sheets and trading at discounts of 20, 30, 40% or more to their highs, you want to own them. Bonds are now trading with interest rates at levels we have not seen in decades. Both stock and bond valuations are looking as attractive as they have in years, and I think long term investors are going to be very happy in the near future for ignoring the naysayers and staying the course.
Please let me know if you have any questions.
Best regards,
Larry
October 3, 2022
Greetings,
The third quarter wrapped up last week with the S&P 500 down 4.88% for the quarter and 23.87% YTD. Bonds, as measured by the U.S. Aggregate Index struggled as well finishing the quarter down 4.75% and 14.61% YTD. We are on pace for the worst year on record for the U.S. bond market. Bottom line, third quarter statements will be ugly. Markets sold off on worries of the FED hiking rates too aggressively, possibly pushing the U.S. economy into a recession. As Yogi Berra once said, "It's Deja Vu all over again". I did take advantage of some of the selling and added to U.S. stocks across Moderate to Aggressive Growth portfolios and I will continue to take advantage of traders’ continued pessimism.
Once again, we feel the market fears are overblown and do not forecast an imminent recession. However, there is an increasing risk that the FED does get too aggressive with rate hikes and does indeed tip the economy into a mild recession - I can no longer rule out that possibility based on the latest "Fed-Speak". In my opinion, the FED is talking tough to make up for the fact they were so wrong about inflation just a year ago. If you recall, last September, FED Chairman Powell said inflation was just "transitory" and did not anticipate any need to hike rates in 2022. Let's hope they don't get it wrong again by getting too aggressive as we continue to see signs of inflation cooling as commodity prices are still dropping, shipping rates are well off their highs along with housing and rents starting to roll over - all good news on the inflation front.
People often ask me what will happen if we do indeed fall into a recession. By definition, a recession is two consecutive quarters of negative economic growth as measured by GDP. Although we can’t predict the future, especially when it comes to the markets, we can learn a lot from the past. According to CNBC, since 1950 the average stock market decline when a recession hits, is 31%, which we are very close to already. The average return 1 year from those lows is 23%. The average total return 3 years after is 47% and the average return 5 years after is over 100%. Those numbers tell me not to panic. Patience, though likely starting to wear thin, will prove to be the winning strategy. Also worth noting...history shows us that FED rate-hike-induced recessions are typically mild and shallower than average.
Third quarter corporate earnings announcements kick off next week and overall, earnings are still expected to rise 5%. While the economy is indeed weakening, by and large, U.S. corporations continue to weather the storm and are still growing earnings which is what matters most when it comes to stock performance. The September CPI (Consumer Price Index) will be announced on October 13 and is sure to be a market mover.
One last point to put this year's selloff into perspective. I pulled up a chart of the S&P 500 from January of 2009 through January of 2020. There is a pretty clear trendline that the market followed, and average annual returns were about 11.8%. From January 2020 to January of 2022, the S&P 500 went up about 50% in those two years. From the lows of the pandemic, the market went up a staggering 100%. This year's pullback has basically washed out the excess returns of those two years and the market is sitting right back at the long term trendline, and the average return from January of 2009 to today is back to 11%. S&P 500 profits have grown by about 10% per year over the same time period. What is the average annual return of the market post World War II? 11.19%.
As I always, I will continue to monitor market and economic conditions and act accordingly.
Please let me know if you have any questions.
Regards,
Larry
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly
Investing involves risk, including possible loss of principal.
August 31, 2022
Greetings,
Summer is winding down and companies have wrapped up their second quarter earnings announcements and forecasts. For the most part, corporate earnings have held up relatively well in the face of higher inflation, higher interest rates and a slowing economy. According to LPL Research, corporate profit growth is tracking to a 7% year over year increase, which isn't spectacular but also not the negative growth some doomsdayers had been forecasting.
The markets have had a nice bounce off of the June lows, with the S&P 500 rallying close to 17% before giving back a portion of those gains the past couple of weeks. We saw some intense selling pressure on Friday as FED Chairman Jerome Powell reiterated the FED's commitment to fighting inflation and raising interest rates further. I suspect traders took that as an opportunity to book recent profits.
As we close out the third quarter and enter into the fourth quarter, we feel the markets are poised for additional gains as the FED will likely begin to signal a pause in future interest rate hikes as inflation continues to cool and the U.S. economy likely avoids an imminent recession. A recession is coming, they always do and are a part of a normal economic cycle. LPL Research, and other economists I follow, feel the next recession is likely later rather than sooner.
The mid-term elections could stir some additional volatility, depending on the outcomes. Historically, the markets do experience heightened volatility leading up to elections. More "hawkish" comments from the FED could also cause additional selling pressure. But, if inflation shows continued signs of easing and corporate profits continue to hold up, I will view any additional weakness in the markets as a buying opportunity. I am still slightly overweight cash in portfolios and will take advantage of those opportunities as they arise. You can also expect to see some repositioning of portfolios over the next few weeks to take advantage of tax loss selling.
Please contact me if you have any questions and have a great Labor Day weekend!
Regards,
Larry
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
All investing involves risk including loss of principal. No strategy assures success or protects against loss.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
July 20, 2022
Greetings,
The first half of 2022 goes down as the worst for the U.S. stock market (as measured by the S&P 500) since 1970. Interestingly, in 1970, the S&P 500 lost 21% in the first half of the year but recovered 27% in the second half of the year. Hopefully history repeats itself.
The first half of the year can be summed up with one word…Fear. Fear that the Federal reserve will raise interest rates too aggressively to fight inflation which could inevitably push the economy into a recession. There is some good news, however, starting to surface that I feel will lead to the Federal Reserve tapping the brakes on rate hikes sooner than what the market is pricing in. Money supply growth is finally starting to slow down - the unprecedented growth in the money supply, driven by government stimulus is likely the leading cause of inflation the last twelve months. The FED’s preferred inflation gauge, Personal Consumption Expenditures has fallen for the second month in a row and commodity prices, which are a leading indicator of inflation, are starting to decline. I pulled up charts from the Wall Street Journal of several commodities and you might be surprised to know that from their peaks a couple of months ago; lumber is down 39%, wheat is down 29%, crude oil is down 15%, wholesale gasoline is down 19%, copper is down 23%, natural gas is down 40%, silver and gold are down 25% and 11% respectively. China has finally reopened, shipping costs are starting to fall (down roughly 27% per the Global Container Freight Index) and supply chain constraints are easing, all of which should also help tame inflation. The economy is already slowing down significantly from last year which should start to ease the demand side of the equation on inflation as well. Bottom line, it appears the FED rate hikes are starting to work through the system and we may have had peak inflation a couple of months ago which could give the FED reason to pause later this summer or early fall. Corporate earnings estimates, while likely to come down, have thus far shown remarkable resiliency in the face of it all, still expected to rise 10% on the year. Add it all together, and investors will likely be very happy they rode out the storm of 2022.
Please let me know if you have any questions. And, have a Happy and Safe 4th of July!
Regards,
Larry
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
All investing involves risk including loss of principal. No strategy assures success or protects against loss.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.