Despite a Friday rally, stocks suffered their 6th consecutive week of losses last week, as the market continues to weigh the risk that the Federal Reserve’s aggressive campaign to bring down inflation could push the economy into a recession. The S&P 500 finished the week down -2.35% on the week and is more than 15% off its peak. The Russell 1000 growth index suffered worse on the week -2.92% and is down 24% from the peak on December 27th. .
Wall of worry about economy and inflation
Investors appear increasingly concerned the Fed will have a hard time battling back historically high levels of inflation without crushing economic growth. Our view is the Fed will likely continue to raise rates aggressively over the next few meetings, to put the brakes on the economy, before easing back later in the year as the economy begins to slow and inflation starts to gradually move back toward more tolerable levels.
For investors we don’t think it is overly constructive to worry about whether the economy will technically tip into a recession. Investment markets have their own cycle and market declines can and do often occur without the economy entering a recession. In fact, when looking at major declines in the S&P 500 over the last 70 years there is only a 4% difference in the average market decline during a recession vs. periods where there is no recession (-27.3% vs. -23.1%). source: strategas
The reality of the day is, there is a lot of uncertainty over the short and intermediate term. Many of the large Wall St. institutions recently updated their 2022 forecast for the S&P 500 and the consensus is a collective shrug of the shoulders. Goldman Sachs for example, laid out a scenario where the S&P 500 rebounds nearly 17% from today’s level to finish the year flat while also saying if the economy tips into a recession it could fall another 10%+. This report underscores the wide range of potential outcomes for the back half of the year. Investors do not like uncertainty which is evident by the most recent investor sentiment surveys that show individual investors are their most pessimistic since 2009.
How we are approaching the current market environment
- Emphasis on quality.
We are putting an emphasis on owning companies that are dominate within their industry, have demonstrated the ability to consistently generate earnings and have pricing power to keep up with inflation. We believe these “all-weather” stocks often get oversold during periods of market stress and will be the first to experience a rebound. We are pursuing these companies through active mutual fund managers.
- Disciplined holds on “growth” positions
Growth stocks are those stocks with expectations of high future earnings growth. In other words, they are an investment in the future of a company vs. the earnings that company may be generating now. When interest rates rise, investors tend to shift away from growth companies in preference of those companies earning money now. We believe growth stocks have adjusted in price to reflect future interest rate hikes and, while there is likely still more volatility ahead, once the economy cools and the pace of rate hikes slow, they will be able to reverse course. Our long-term strategic sleeve maintains positions in high growth sectors.
- Getting back to neutral on bonds
Low yields and rising interest rates have made bonds a very tough place to be invested the last several years pushing money into stocks and bonds have experienced one of their worst periods in history to begin this year. However, as yields climb bonds are starting to become a place where investors can earn something on their money while providing some risk protection for portfolios. We are gradually removing our underweight allocation to bonds.
- Elevated cash levels
Since the beginning of the year we have generally held elevated cash positions in portfolios as a way to maintain some dry-powder. We expect to systematically invest cash through the back of the year.
It’s important to remember that markets regularly go through periods of negative returns and thus far the pullback, this time around, has been rather orderly. Eventually, inflation will come down, interest rates will level off and supply chains will improve and as they do stocks and portfolios will correct accordingly. In the meantime, we will continue to harvest tax losses, look for opportunities and manage portfolios to each clients specific goals.
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