Jun 2, 2022
The theme of our letter at the end of 2021 was to expect to be surprised. It’s fair to say the first four months of 2022 was full of surprises. For many of you, the speed by which the market has moved has been a shock, but that is typically how these types of corrections occur. The important thing to remember is that while it’s hard to predict when these moves will occur, we do know that they will occur, so we seek to build portfolios that help you navigate through the challenging times.
First, let’s quickly reflect on the big events we experienced over the last four-plus months:
- Inflation continued at a torrid pace, hitting 8.3% year-over-year, albeit a slight drop from the prior month (the high-water mark).
- Massive liquidity in the capital markets and consumers’ pockets moved from expansion to contraction, as historic fiscal and monetary stimulus activity began to wind down.
- The US Federal Reserve moved from “dovish” to “hawkish” policy to fight inflation – in March, they raised overnight interest rates for the first time since 2018 by 0.25%, and another 0.50% in May. To fight the inflation, the Fed could be on pace to raise rates to more than 2.0% by the end of this year.
- The broad bond market experienced a negative price return for the first quarter period not seen since 1994, as investors reacted to the expectation of higher rates. This is a unique time where both stocks AND bonds are experiencing price declines.
- Russia invaded Ukraine, triggering sanctions and supply chain constraints that drove up prices of commodities including oil, natural gas, wheat, and even neon (a semiconductor input).
- Stock markets across the world swooned on the back of all these shocks with the S&P 500 ending the month of April at negative 12.9% for the year-to-date period, and the more tech and growth-oriented NASDAQ Index was down 21.1% for the same time-frame.
If you were watching the financial media, you would have been getting the complete play-by-play of panic along with the doom-and-gloom that would drive one to hide under their desk. Remember that fear sells, so please take our oft shared prescription: turn that noise off. And as we have constantly written, while it is not fun and certainly scary, these types of market shocks are normal, and you must be prepared to live through many more of these.
The positive note here is that you should not underestimate the ability of a strong economy comprised of strong companies and consumers to learn how to adapt to the many challenges that will arise. It’s easy to extrapolate a negative trend and think it will only get worse, perhaps leading you to make a bad decision at a bad time. Just like a pendulum, our emotions can swing from one extreme to the other.
But the truth is, especially in America, we do learn to adapt. If prices are high or supply is short, we change our behavior or we buy substitutes. Companies are smart too – when prices are high, producers that may not have made or sold products at lower prices will step in and add supply when profitability is more likely.
Also keep in mind that it’s a global economy. Europe is in trouble now given its over-reliance on imported oil from Russia, but places like the US and Canada could step up production (albeit with some lead times). In a similar vein, North and South America could step up agricultural production as Ukraine produces less.
The two key points here are:
- The markets, and therefore your investments, will continue to go through cycles of over- and under-reactions to both positive and negative shocks; however, there are natural “shock-absorbers” that help guide asset prices back to a long-term (and likely positive) average path over time. Don’t just extrapolate to the most optimistic or pessimistic scenarios. Rather, look at overreactions as opportunities for profit, not panic.
- Your best strategy is to continue to buy durable companies with the financial strength to adapt to various market shocks. Just like the story of the six-foot man that drowned in the river with a 4-foot depth on average, remember that good businesses will grow over the long-term, but you must be prepared for the occasional (and sometimes extreme) tough times. Be vigilant about understanding how things will hold up when those “floods” do happen. Warren Buffett reminded us that a series of years with positive returns multiplied by one year of zero, is still zero. Know your risk.
At NPF we are pleased to be able to guide our clients through these cycles and we work hard to vet good quality, durable stocks and bonds for our client portfolios. And for long-term financial plans, there is a reason why we use equal doses of reasonable and conservative assumptions to make sure your plan is resilient and can survive the occasional bumps along the way.
To do better, you need to think differently, and you shouldn’t settle for average. That is what we are here to do for our clients, and we are grateful for the opportunity to serve all of you.
Sincerely,
NPF Investment Advisors
