Broker Check


SECOND QUARTER UPDATE - 2022

| April 18, 2022
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“In investing, what is comfortable is rarely profitable.”
– Robert Arnott

LOOKING BACK, LOOKING FORWARD

Blindsided by one of the "known unknowns" that are always lurking in the background and

can upset existing market narratives, markets reacted to Q1's rising inflation. Investor

expectations coming into 2022 were modest – economic growth may come slowly but

remain solid, and stocks were forecast to rise, though not at the pace of 2021.

In the new year, investors were fully aware that inflation was proving more durable than

"transitory" and that interest rates could head higher. Yet, it was only upon the turn of a

calendar page that investors seemingly contemplated what that potentially meant, i.e.,

a more aggressive Fed, a slowdown in corporate earnings growth, and a devaluing of

high-growth companies whose earnings may be in the distant future.

In one respect, the market correction in the first quarter (defined as a decline of 10-20%

from recent market highs) shouldn't have come as a surprise to experienced investors

since there have been 27 such declines since World War II, with the last one occurring

in 2018. By historical standards, a correction was overdue. Past corrections have had an

average decline of 13.7% and last for about four months (not including corrections that

turn into bear markets, i.e., a decline of 20% or more).

Nevertheless, historical performance is only a guide, not a guarantee of the future. So,

as investors look forward, they may see three significant headwinds for the market:

inflation, higher interest rates, and potentially wider geopolitical issues.

While a tighter monetary policy is the Fed's primary tool in fighting inflation, its ability to

dampen inflation over the near- to intermediate-term may be limited since higher interest

rates take time to work through the economic system. Also, a tighter monetary policy will

do very little to solve current supply chain problems – a significant contributor to rising prices.

While higher rates may be effective for lowering inflation longer term, it may come at a

short-term cost to investors. Higher interest rates, along with any shrinking of the Fed's

balance sheet, has reduced liquidity in the markets, which has put some downward

pressure on stocks.

The wild card seems to be what Russia does next, which could be as disparate as agreeing

to a withdrawal from Ukraine with a promise to respect Ukraine’s territorial integrity to the

highly unlikely but concern of invading additional countries and ratcheting up tensions with

the West.

A peaceful resolution to the Ukraine crisis may be met with deep relief by investors,

potentially allowing markets to rally and return the focus to economic fundamentals, like

GDP growth, inflation, and corporate profits. A widening of tensions could prove problematic

to the financial markets and the economy.

We've seen markets unsettled by war in the past. They tend to regain their balance in a

relatively short period. I’ve shared the charts in the past, but 5 out of the last 5 times

there were invasions, markets set the low on the day of the invasion. So far, this is true

in this situation as well.

THE DOG IS LURCHING IN MANY DIRECTIONS

One can compare the stock market to an excitable dog on a very long leash. The least bit

of stimulus and it begins darting randomly in every direction. The dog's owner may be

walking northeast to the park. At any one moment, there is no predicting which way the

pooch will lurch. But in the long run, you know he's heading northeast at an average speed

of three miles per hour and is going to the park. What is astonishing is that almost all the

market players, big and small, seem to have their eye on the dog, and not the owner. After

all, we know where the owner is headed and where he will eventually be. Yet, we cannot take

our eyes off the dog. This is why Warren Buffet says he wishes the market would just shut

down for years at a time. We wouldn’t be able to react to the dog’s every move and just know

we’ll see Fido and his owner at the park.

There are several distractions for this “pup-like” market.

Inflation distraction. Costs are rising across the board. From used cars to gasoline to housing

to food, most everything costs more than it did last year.

Fed tightening distraction. Interest rates are going up and easy money policy is going away.

When you print trillions of dollars and throw it into an economy, prices are going to go up. It

is inevitable. Add those trillions of dollars to a supply constrained economy and the prices

move up even faster. This is where we are. The good news is while the Fed is beginning to

raise rates, the free market is doing a lot of the heavy lifting. The Fed raised rates one quarter

of one percent in April, yet mortgage rates have risen almost one full percentage point in the

last 30 days. Higher mortgage rates will slow housing affordability, which in turn should begin to

put pressure on ever increasing home prices. As borrowing costs increase, there will be less

spending. Eventually, less spending puts downward pressure on prices.

COVID-19 distraction. While waning in the U.S., the specter of another wave keeps some

investors nervous. China’s zero case policy didn’t work and now its ripping through the country

just like it did everywhere else. This brings us to our next distraction.

Supply chain distraction. While the temporary shutdowns in China may exacerbate short-term

supply constraints, most of the damage was done during the long shutdowns of 2020. Throw in

a few extra trillion dollars of demand (thanks to the Fed) and manufacturing just hasn’t been able

to catch up. Yet. The best cure for high demand and high prices is higher prices. As I mentioned

above, borrowing is becoming less affordable and will eventually curb spending. As spending slows,

manufacturing will have a chance to catch up. Supply chains and shipping have been improving

lately. Again, the temporary shutdowns in China may temporarily delay the recovery, but as quickly

as Omicron moves in, it tends to move out just as fast.

Geopolitical distraction. Russia invades Ukraine. While the burden is quite heavy for the people of

Ukraine, history has shown events like this to be temporarily disruptive to the world economy. This

doesn’t take away from the cruelty the Ukrainian people are enduring. Invading a sovereign nation

in today’s world should be met with harsh consequences. Debilitating economic sanctions will

eventually work to slow Russian resolve. With all these distractions, there are other clues we must

focus on.

Labor productivity is at an all-time high.

Unemployment is very low. Anyone who wants a job can have not just one, but two.

Innovation is still happening.

Again, the free market is doing some of the heavy lifting for the Fed. American, Chinese and

European consumers are facing various headwinds which will work synergistically to curtail

borrowing and spending. This means the Fed may actually have to do less tightening than

anticipated. The jury is out on how much the Fed has to do, but the free market is far more

efficient than government bureaucrats.

Finally, there are some technical indicators which point to the market low set in February being

the low of this cycle. There is no forecasting tool that is 100% accurate, but 8 of 9 times markets

were higher a year out using these indicators.

If you remember one of the themes of last quarter’s commentary, you may remember the four

words that can best summarize Horizon Preference… “This too shall pass.”

FINAL THOUGHTS

The following is an excerpt from a recent weekly commentary I sent out. It may be more accurate

now than it was few weeks ago. There is a lot of negativity out there currently, but I will leave you

with this.

This past weekend despite the negative news and high gas prices, families took their kids to Disney

World. They went to soccer, softball, baseball and volleyball games, then went out to dinner at local

restaurants. Americans across the country went to Walmart, Target, Lowes, Home Depot and here in

the south, Publix, and they bought things they wanted or needed. The Amazon, UPS and FedEx

trucks were also busy delivering eagerly anticipated items to those who ordered them.

My neighbors had a wedding in their back yard and I’m sure there were weddings all across America.

Imagine that, a bear market can't kill love. Ha. I’m getting soft in my advanced years. So, families are

being formed and doing what they tend to do… grow, work and spend money. The consumer drives

the economy, not CNN or Fox News. Yes, higher gas prices for a long time could shift where some of

that money is spent, but you are still going to be you and you are still going to want to go out and do

things. The human spirit tends to find a way even when it seems like there might not be one. I can’t

tell you what the market is going to do in the next few months, but I wouldn't bet against you.

Our portfolios remain invested in businesses that, in aggregate, generate solid cash flow and maintain

strong balance sheets. In today’s market environment, even great companies will experience some

volatility. The reality is one must remain invested through all markets to be a successful investor.

Trying to time or jump in and out the market based on sentiment has proved to be a fool’s errand at best.

If life events have forced you to rethink your goals, let’s talk. Financial plans are not set in stone. Yet,

adherence to one’s financial plan and a long-term focus have historically been the straightest path

to reaching one’s goals. We may see volatility this year. However, keep in mind predictions are simply

educated guesses. As we’ve seen in the past, sell-offs when they occur, are followed by rebounds.

Keep this in mind as we navigate the rest of 2022 together.

If you have any questions or would like to discuss anything in this update or any other matter,

please feel free yo give me a call. As always, I’m honored and humbled you have given me the

opportunity to serve you.

Sincerely,

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