Correction and contraction….
Investing during 2022 has been like running an obstacle course for the first time – walls to scale, water hazards to cross, fallen trees – you get the idea. To-date, economic, coronavirus-related, and geopolitical events have taken a toll on stock and bond markets, as well as the U.S. economy. Four key points affecting investments are:
- Prices were high as we entered the year and have continued to rise. Last week, the Personal Consumption Expenditures Price Index, a broad gauge of inflation across the United States, reported that inflation was 6.6 percent in March 2022, up from 5.8 percent in December 2021. This number, in our opinion, is understated.
- The Russia-Ukraine War is pushing inflation higher. Inflation was already an existential threat imputed to the conflict in Ukraine. Russia and Ukraine are one component of inflation as they are major exporters of energy and agriculture products, and exports have been limited by the war. Consequently, the World Bank’s Commodity Market Outlook forecasts that energy prices will rise by 50.5 percent and non-energy prices by 19.2 percent this year before moving lower again in 2023.
- China is locking down cities to fight a surge of COVID-19 and snarling supply chains. “Ships have been piling up outside Shanghai, the world’s largest port, and other container docks across China as authorities have forced multiple cities into lockdown to counter the country’s worst COVID outbreak since the pandemic began,” reported Eamon Barrett of Fortune. Cross-border restrictions on trucking have also created issues.
- The Federal Reserve began raising the fed funds rate to address inflation. The Fed is expected to raise rates significantly this year as it works to reduce demand and lower inflation. When interest rates move higher, the cost of borrowing increases, and economic activity slows. As a result, some investors are concerned about the possibility of recession.
Recession fears were top-of-mind last week when the Bureau of Economic Analysis reported that U.S. gross domestic product (GDP) – the value of all goods and services produced in the country – contracted 1.4 percent during the first quarter of 2022. Greg Daco, chief economist of EY-Parthenon, wrote in Barron’s:
“To the untrained eye, such a GDP contraction would raise concern that the economy is headed toward a recession…paradoxically, the main reason GDP contracted in Q1 is that the U.S. economy grew faster than its peers. Robust private sector activity driven by solid consumer outlays, accelerating business investment, and inventory restocking pulled in imports at an extremely rapid pace while a sluggish global economy meant exports fell back.”
Major U.S. stock indices fell last week. The Standard & Poor’s 500 and Nasdaq Composite Indices are in correction territory, down more than 10 percent for the year, and the Dow Jones Industrial Average is close to a correction, reported Ben Levisohn of Barron’s.
|Data as of 4/29/22||1-Week||Y-T-D||1-Year||3-Year||5-Year||10-Year|
|Standard & Poor’s 500 Index||-3.3%||-13.3%||-1.9%||12.0%||11.6%||11.5%|
|Dow Jones Global ex-U.S. Index||-1.8||-12.6||-13.7||2.2||2.6||2.8|
|10-year Treasury Note (yield only)||2.9||N/A||1.6||2.5||2.3||1.9|
|Gold (per ounce)||-1.6||5.0||8.4||14.3||8.8||1.5|
|Bloomberg Commodity Index||0.4||30.6||43.6||17.2||9.0||-0.8|
S&P 500, Dow Jones Global ex-US, Gold, Bloomberg Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.
Sources: Yahoo! Finance; MarketWatch; djindexes.com; U.S. Treasury; London Bullion Market Association.
Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. N/A means not applicable.
WE BELIEVE VALUE STOCKS MAY BE CYCLING INTO FAVOR. For more than a decade, interest rates in the United States have been very low. During this time, growth stocks, which benefit from low rates, have outperformed value stocks. As of last Friday, the MSCI All-Country World Index (ACWI) Growth, which measures the performance of growth stocks, was up 9.51 percent for the last decade. The MSCI ACWI Value, which measures the performance of value stocks, returned 4.47 percent, over the same period.
It looks as though that may be beginning to change.
Growth stocks are shares of companies that are expected to grow more quickly than other companies. These companies often do not pay dividends. Instead, they reinvest any profits to grow the company quickly. The valuation of growth stocks may seem expensive; however, if the company grows fast the valuation may seem low and the company’s share price may rise. Many technology companies fall into this category.
In 2022, growth stocks have languished. “High-growth technology stocks that sparkled in the coronavirus crisis have entered a bear market as shifting consumer habits and the prospect of sharp U.S. interest rate rises force investors out of one of the most lucrative trades of recent years…the prospect of rate rises has hurt low-profit, high-growth technology stocks because those companies’ future cash flows look relatively less attractive,” reported Laurence Fletcher of the Financial Times. We don’t always agree with such publications, but Fletcher is reporting much of what we believe.
Value stocks are shares of companies which trade at valuations that are lower than company fundamentals – earnings, dividends, sales, cash flow, and other metrics – suggest. Often these are mature companies that pay dividends. Some of these were growth companies at one time.
Historically, there have been periods when value has outperformed growth. For example, this year, through last Friday, value stocks (MSCI ACWI Value, -6.69 percent) delivered better returns than growth stocks (MSCI ACWI Growth, -20.03 percent).
Recent performance doesn’t mean it’s better to own value shares instead of growth shares, or vice versa, as Saira Malik of FT explained. “Of course there have been times when value has beaten growth and vice versa – sometimes by wide margins and for extended periods. But betting on one style over the other based on the magnitude or duration of its past outperformance in any given timeframe is not a sound strategy for maximizing returns. The reason is simple: performance drivers are period-specific, hard to predict and unlikely to be repeated.” From our perspective, one of the best choices is diversification. Holding a well-allocated and diversified portfolio won’t eliminate losses, but it can help investors manage risk during periods of market volatility.
The remainder of 2022 is likely to bring more volatility, perhaps enough to create visceral emotions among investors of all types. Now is no time to let emotions drive decisions. Ripping apart your investment strategy is not a means of controlling risk. On the contrary, these very market conditions prompt investors to make rash decisions based on emotions which are evoked by pervasive pundits who thrive on promoting fear. Don’t get me wrong, these times are unprecedented and warrant a more careful approach to investing and wealth management. Precisely the time where a voice of reason is most valuable, and needed. If you are concerned, having second thoughts, or simply want to review your current plan for additional clarity, give us a call today.
Weekly Focus – Think About It
“In the long run, we shape our lives, and we shape ourselves. The process never ends until we die. And the choices we make are ultimately our own responsibility.”
—Eleanor Roosevelt, former First Lady
Phillip L. Clark, RFC
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