For those of you who do not know the significance of Riding the Rockies, it relates to a charity bicycle ride that I do a bit more infrequently to benefit the Denver Post Foundation and small resort communities that make their money in the winter but starve during the summer. It is the equivalent of 5-6 days of century rides (100 miles), with a little altitude and some vertical climb thrown in, just for grins.
I have not ridden this ride over the past three years and because of some family commitments I will not do it this June, either. Several of us are, however, putting a group together to go next year so if you like to cycle and have an interest, please reach out to me, and let me know.
We often use the analogy of the markets “climbing” that wall of worry, though, over the past week, it appears to have been descending that wall of worry at a fast clip. Over the past couple of days, we have begun to get some emails/texts/phone calls from clients about the volatility in their portfolio values. Some of our clients have been with this firm for over 30 years and we monitor these kinds of calls of concern as often being a “bottom marker.” We believe that we are close to, but probably not at the bottom, yet.
Now, we know that watching a bottom-line number on a statement dissipate is not ‘fun” and at some point, is “concerning.” The challenge is that if we take a lot of gains in the portfolio to go to cash, we cause the client to incur either long or short capital gains tax, usually, and we then run the risk of missing out on a big sweeping, higher volume up day like last Friday to recoup some of those gains.
The current market action, as I explained last week is much different from that of 2001 or 2008. We do not believe that at present there is heightened “systemic” risk. This is risk which tends to be unanticipated and results in a threat to the very functioning of a financial system. There are several indicators that we watch which typically rise leading into a systemic risk event and we are not seeing any meaningful movement of those indicators to reflect a risk to the “system.” This is much different than what we witnessed in 2008-2009.
Rather than systemic risks, we are of the view that the markets are correcting as interest rates rise and are forecast to rise further. Many of the technology stocks, for example, ran up quickly and then have come back down, resulting in price/earnings multiples that are very similar to those now of defensive stocks like consumer staples. The net result is that technology stocks now look cheap when compared to so-called consumer defensive stocks.
From a fundamental perspective, investors are worried that higher interest rates, coupled with supply chain disruptions and essential supply shortages may result in higher consumer prices and push the economy into a full-blown recession.
Let us talk about our game plan here, and how that may impact your portfolio:
- We believe that there may be some additional downside volatility in stocks. We know that as the Fed raises interest rates, bond values will continue to decline.
- There is virtually no “shelter” in markets this volatile. Stocks, bonds, real estate, even cash, all suffer in periods of high inflation, rising interest rates and slowing growth.
- The objective is to try to minimize losses and position for the bottom of the cycle and the rebound higher.
- We think that the Federal Reserve has failed to address spiraling inflation soon enough and is playing catch-up. As a result, they will probably tighten too much which will put our economy into a shallow recession.
- We do not sell into “panic.” We sell when there is heightened systemic risk. We sell when a company’s fortunes have changed so significantly that the risk of not selling is greater than the risk of selling.
We do not believe that this will be a “quick fix,” or a “V-shaped” recovery. We believe this may take 18-24 months to work out. What we do believe is that it has placed many great American companies on sale, and we are qualitatively assessing our portfolio holdings, selling those with lesser prospects and adding to those that appear to be trading at deep discounts with better fundamentals or growth prospects. We think that there will be some continued volatility as investors weigh the risks of heightened inflationary trends vs. the impact from Federal Reserve rate hikes.
The trapdoor sell-off in retail stocks which came on the back of Philly Fed President Harker’s guidance to two 50 bps rate hikes in June and July and reports from Target and Walmart about higher inventories relative to sales, appear to reflect that inflation has sucker-punched the American consumer and he/she are not spending, resulting in inventory backups.
Walmart reported inventories that are at their highest levels in 20 years. Some of this might be attributable to the mathematics of higher prices: inventory mix and prices may be raising the value of inventories relative to sales, but the general trend appears to be discernable.
The implication is that retailers may experience lower profitability and that they may also need to liquidate inventories through price cutting.
One area that shows some promise is homebuilding where there continues to be strong demand, despite higher mortgage rates. One of the significant issues within this sector is supply chain constraints which are prohibiting construction companies from completing new home starts. Implied completion times because of supply issues range from 10 months for the average single-family home to up to 3 years for multi-family housing units. This is a staggering time delay. Clearly, a return to some degree of normalcy in supply chain disruptions would help alleviate these pressures and boost homebuilder productivity where demand for housing units remains very strong.
Just to crystalize our views:
- We think that the Federal Reserve was late to the inflation party and is about to overshoot interest rates as supply chain disruptions and higher consumer prices have killed (past tense) consumer demand.
- We believe that the Fed will overshoot with rates, resulting in a mild recession in late 2022.
- The stock market may test S&P 3400 in our view, but could trend lower and then, should bounce.
- We believe that this is an opportune time to explore some of the new generation fixed indexed annuity products which are now priced more favorably since bond yields have risen. If your annuity is benchmarked to an underlying index strategy, or to a good, fixed rate of return, what better time to take advantage of low index rates of return.
If you have any questions about any of these topics, please contact me at [email protected] or, call me directly.