Beyond The Headlines
First Half 2022 Review
Never a dull moment — that’s the best way to describe the last two and half years in public equity investing. We’ve had a flavor of a late bull market (early 2020), a panicked pandemic sell-off (spring 2020), a quick market recovery (2020-21), followed by yet another correction (late 2021 to summer 2022).
It feels like a very long journey, yet in some ways, we are exactly where we started. Interest rates, 10-year treasury rate, and unemployment rate are all back to pre-pandemic levels; many stocks erased the pandemic gains, too.
S&P 500 and Nasdaq in mid-June were a mere 10% above the pre-pandemic early 2020 high, while the Dow Jones was almost exactly where it was 2.5 years ago (Source: Bloomberg).
As much as in 2021, we saw many stocks trade close to their multi-year highs, today in mid-2022, it’s not the case. Some securities rose year-to-date; some came under pressure, while others experienced a big 80-95% drop. Volatility returned to the market and produced what we found to be a refreshing variety of outcomes for stocks.
There are many more potential investment ideas worth considering than in two and a half years.
Some statistics may suggest that the last 2.5 years didn’t happen, but one metric stands out. It is definitely not where we are used to seeing it – inflation. US Bureau of Labor Statistics reported that the US inflation rate reached 9.1% in June, the highest read in 40 years (November 1981). It was driven by energy, which rose 40% y/y, but food alone increased 10% as well. All items less food and energy were up a little under 6%.
Inflation might be more difficult for weaker, low-margin businesses, where costs represent a higher portion of sales; these are businesses we tend to avoid. All in all, inflation is a tidal wave that affects everyone, consumers, businesses, and governments. If left unchecked, it can be a very disruptive force.
It’s no surprise that the Federal Reserve and other central banks around the globe finally took notice and started raising rates.
Monetary easing and fiscal help of the last two years propped up the demand but didn’t do much for the supply constraints – some long-term in nature, some caused by pandemic dislocations. We believe higher rates should eventually be able to curtail demand to match up with supply and ease the inflationary pressures.
We also witnessed foreign exchange shifts with the dollar strengthening against the euro (reaching parity for the first time in twenty years), the pound, the yen, and emerging market currencies, with Turkey and Argentina dropping the most. This has further implications, especially for countries relying on imports and dollar-denominated debt.
Why is the dollar the strongest in a generation? There might be many reasons: 1) The US is in better shape than other parts of the world 2) the dollar, which is one side of 90% of foreign exchange transactions globally, is considered a safe haven in uncertain times 3) the Fed has been moving aggressively with interest rate hikes compared to other big, developed economies.
The stronger dollar might be a mixed blessing for US companies, especially those with big international sales.
More opportunities ahead
We have been browsing and researching closely more stocks than we have in a while. Among the growing group of stocks whose prices are almost exactly where they were 2.5 years ago, we see bigger, better businesses than before Covid. Those companies, though, trade at the lowest valuations we have seen in years or ever. We get a lot more, but we pay a lot less. It doesn’t mean they won’t get any cheaper, but it means there are many more stocks worth considering than 6-12-18 months ago. There is definitely more to look at and consider, even if we proceed slowly.
Two tech worlds
The previous darlings of the market, many of them broadly defined tech stocks, got divided into very distinct groups. The first consists of large, more mature, established, and profitable companies, and the other are newer, formerly exciting, but still unproven, and money-losing growth stories. If Facebook (or Meta) could represent the former, Peloton or Carvana could be a proxy for the latter. Both groups came under pressure, but the first dropped in price by some 35% on average, the latter closer to 80-95%.
Looking for a new normal
Beyond the ups and downs, it seems that everyone is looking for a new normal. Supply and demand have been out of whack at both extremes. There was the moment we had all the supply but no demand – hotel rooms and airplane seats in 2020; later, last year, we also had all demand and limited supply – in homes, cars, and more. Businesses tried to catch up with demand and look for it in new places. Sales and ad spending moved online, and consumers migrated from formerly busy metropolitan downtowns to the suburbs, and even rural areas as sales and services moved online.
How much of what we saw was a permanent shift, and how much was a temporary phenomenon soon to fade away from memory? We are yet to see. Some companies saw record growth, followed by a decline in demand. We saw oil prices at $60 (pre-pandemic), then at $20 in March 2020, and $110 in May 2022. The conflict in Europe further exaggerated the pandemic’s ups and downs.
Our long-term goal remains the same for all the assets we manage. We intend to both preserve and grow the capital over time. We seek to double our clients’ wealth every 5-15 years, which translates to a 5-15% annual rate of return over the long run, but we would like to accomplish it without exposing the portfolios to the risk of a permanent loss of capital. Of course, performance cannot be guaranteed, and past performance is not indicative of future results.
Our strategy can be described as a long-term patient contrarian. All securities are selected through an in-house research process. Our investment horizon for each individual holding is usually 3-5 years.
We intend to hold between 30-60 stocks, mostly US equities, but we may invest in foreign securities as well. We don’t use any leverage; we don’t own any derivatives. We may supplement the strategy with exchange-traded funds (some of them may use leverage or derivatives).
We don’t have a predefined portfolio composition target. We may hold cash at times, but we prefer to own businesses, and when the opportunities abound and prices are right, we will likely be close to fully invested.
What we wrote before applies today: “as much as we pay attention to the overall market trends, we like to look at our performance independently from the benchmark. As long as the businesses we own report improving fundamentals, and the market eventually prices them accordingly, we are happy.”
The Fed and the Market
After two long years of a zero rate policy, the Fed swiftly (four hikes since March) brought the rates back to where they were right before the pandemic. Why not slower, why not earlier? We may continue to wonder; the point is they eventually had to climb higher from a clearly unsustainable pandemic zero level.
As much as we can argue whether low or high rates are better, it’s the speed of change that’s been disorienting for many. More so because they are rising from nothing to something, thus the cost of borrowing can go up many times over very suddenly.
The policy shift is a balancing act between maintaining growth and employment while keeping inflation in check.
Interest rates, or cost of money, is one of many inputs we believe are worth watching while investing. We have found that rising rates are the biggest strain for the most vulnerable, weak companies, which we tend to avoid anyway. That’s not all, though. The higher cost of money seems to create a tidal wave that affects the entire economy and affects businesses, consumers, and governments.
What we have witnessed these last six months is an adjustment, a correction in behavior given the higher cost of borrowing. We think it’s refreshing and might help purge some questionable investment options that have appeared over the last two years. With zero rates, everything goes; with higher rates, there is a natural hurdle rate.
We wouldn’t give rising rates all the credit here, but they did play a role together with slower economic growth and inflation in shifting the investor and consumer sentiment from overly optimistic to definitely much more cautious or even pessimistic.
It’s a backdrop to our individual investment choices, and we don’t let the tail wag the dog here, but we are definitely watching the new direction of the monetary policy (or a resumption of the pre-pandemic trend?), and the reactions to it among both businesses and consumers.
The Market and the Economy
As much as the Fed might be making waves in both the stock market and the economy, we also like to remind ourselves that the market is not the economy, and the economy is not the market. The economy represents all the economic activity; the market represents all the listed public traded companies.
The economy goes through its ups and downs, corporate earnings respond to it, and the stock market attempts to price in both the good and the bad ahead. In some ways, the market tries to predict the future. In March of 2020, the major indices lost about 1/3 of their price (Source: Bloomberg); months later, the economy had a short-term reading of about 1/3 decline year-over-year (Source: Bureau of Economic Analysis). At that point, though, the market was already on the rise.
One could wonder if the stock market is a good leading indicator. It would be too simple if it was. A famous economist, Paul Samuelson, once said: “the stock market had predicted nine out of the last five economic recessions.” He was right about that. The market tends to panic too many times to be a reliable indicator. Those panics, though, offer buying opportunities.
The economy is slowing down after accelerating in late 2020 and 2021. We went from a hard stop (in Q1 2020 US Real GDP dropped 5.1%, and 31.2% in Q2) to full speed (up 33.3% in Q3 2020, and 4-7% the next five quarters) to looking for the new normal (Q1 2022 and Q2 2022 down 1.6% and down 0.9%). (Source: Bureau of Economic Analysis).
It’s been a very wide range of economic growth in those last two and a half years; down 30% and up 30% are clear outliers and remind us of the shocks caused by the pandemic and the policies that followed. The high single-digit growth rate we saw through most of 2021 was also a reflection of elevated demand. It was a matter of time when we might see a regression to the historical average, or a 2-3%, which is what we saw through most of the previous decade.
We are watching the current economic activity with great curiosity and, even more so, corporate earnings. We believe they should give us a better idea of sustainable supply and demand beyond the last two years. As we mentioned earlier, let’s remember that many businesses are coming out of this period a lot bigger, better, and stronger than before, and they have our attention.
We believe the US economy is still the biggest, healthiest, and most diversified in the world. Given its depth, size, and liquidity, the US stock market seems to remain the most appealing home for the most innovative, new companies, even if they originated in Europe, Asia, Africa, Australia, or South America. At the same time, US companies are global and benefit from long-term growth and prosperity around the world. They operate under US laws, follow US disclosure requirements, and promote a shareholder-friendly culture, making them appealing investment choices for us. We are optimistic about the US, and the US business, while near-term, we remain cautious about the stock market as a whole. We are happy with our stock portfolio of selected, vetted, well-researched businesses.
What do we expect going forward? We build the portfolio for any possible scenario, and our goal always is to be the least wrong with our investment choices. Given the level of uncertainty from inflation, economic slowdown, interest rates to new policies, and now also, the Ukraine-Russia conflict, we are not surprised to see renewed volatility in the markets, and volatility can be a friend of a disciplined, patient investor.
In a rising market, everyone wants to be fully invested; in a falling market, everyone hopes to be completely out of the market. We always proceed with caution. We might have lagged in the second half of the 2021 market rally, but our stock selection has paid off so far in 2022. We often say that what we don’t own matters as much as what we do own.
We kept a steady course when we saw FOMO-driven speculative spirits took over the markets last year.
We have been happy with the holdings we bought, and their performance shows that stock selection mostly met or even exceeded our expectations.
We remain optimistic about the long-term growth prospects of the US and the world economy.
The last two and half years have been a whirlwind of euphoria and despair. I think it’s fair to say that we have lived through two decades of economic history in two and half years.
If one can look beyond the noise, we see many companies gain share and get stronger. We saw the adoption rate of technology in work, business, and education take a massive leap. We saw consumers change their behavior and rethink where and how they want to spend time and money.
Slow and steady wins the race remains our mantra as we look ahead toward new investment opportunities.
The information provided in this article represents the opinions of Sicart Associates, LLC (“Sicart”) and is expressed as of the date hereof and is subject to change. Sicart assumes no obligation to update or otherwise revise our opinions or this article. The observations and views expressed herein may be changed by Sicart at any time without notice.
This article is not intended to be a client‐specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally.