Beyond The Headlines
Second Half 2021 & YTD 2022 Review
Two Years Behind Us
If we look back at 2020 and 2021, stock investments have had clear turning points. Until late February 2020, it looked like yet another decent year ahead with strong fundamentals and peak economic performance. Some could say that it was too good to be true for too long. That’s why we entered 2020 with a fairly cautious stance.
We took advantage of the buying opportunities presented by the March 2020 sell-off. We enjoyed the stock price and business recovery of our holdings through the end of 2021.
That period though was not all smooth sailing for investors. In the first half of 2021, we saw high-flying growth stocks take a break from the rally, only to catch up in the second half of 2021.
As we kept up with our holdings and considered future potential buys, carefully studying each earnings report, we started to notice a shift around summer 2021. We witnessed more disappointment among enthused investors. This new phenomenon continued through the end of the year and further into 2022.
As we are putting the finishing touches on our update (3/2022), the market seems to have hit a temporary invisible wall. It doesn’t mean that there are no compelling opportunities to add to our portfolio, quite the contrary. The renewed volatility already drove down the prices of a good number of potentially interesting companies.
We decided to act and gradually buy some new holdings.
With the latest COVID wave mostly behind us, we are witnessing a quick shift in policies towards fewer restrictions. If that direction continues, we believe businesses, consumers, and workers can hope for some new normal ahead. That’s something we are yet to see and define as we move past the last two very unusual years.
We wrote last time, “although we have seen some unexpected stock market heroes in the last year and a half, it has been one of the most challenging times to navigate.” Late 2021 and early 2022 might have been a refreshing pause in the rally that proverbially lifted all boats. The path forward may not be that obvious. We are always keeping a steady course, and we aspire to be the least wrong. We remain prepared no matter which scenarios play out in the end.
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.
The second half of 2021
In the first quarter of 2021, we saw a rally in small-cap stocks, while large caps, and especially technology stocks, hesitated. In the second quarter and through the second half of the year, small caps traded sideways, while large caps and technology stocks steadily rose.
Around summer, though, as earnings started to come in, we noticed a peculiar shift. There was a growing number of companies that benefited from strong fundamentals and price momentum earlier in the pandemic but were facing some headwinds now.
In many cases, investor enthusiasm pushed the stock prices ahead of fundamentals. The consumer demand remained elevated, but year-over-year comparisons were less impressive. The market proved to be unforgiving to some of those stocks. It created several buying opportunities for us.
It also set the stage for what we saw late in 2021 and early 2022. The market started to cool off from the earlier rally. We witnessed some record-setting daily big drops in a number of stocks that were market darlings only a few short months earlier.
In our mind, it was a sign of the fundamentals prevailing yet again. The actual earnings power mattered more than promises of growth and the excitement of rising price momentum.
We are yet to see if it’s a long-lasting pause in the market rally or a chance for more pockets of weakness in various market segments. As long-term holders and patient, disciplined buyers, we always welcome price volatility and panicked selling.
Finally, it’s worth noting that the market valuations came down. As earnings rose, the stock prices dropped. It’s too early to say that the market as a whole looks compelling, but we believe there are definitely more opportunities around than in a while.
What we wrote last time 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.”
Interest rates on the rise
Things finally got interesting on the interest rate front.
Last time, we mentioned the staggering fiscal and monetary help that came unleashed when the pandemic hit. We also added how the Fed’s monetary support never paused. Later in 2021, the Fed started to get ready to back away a bit. The inflation fears set the stage for some potential interest rate hikes going forward.
1-year treasury rate spiked in late 2021 to over 1%, it was around 0% for most 2020 and 2021, and for reference reached over 2.50% in mid-2019, after a steady but slow 5 year-long rise from near zero territory between 2009 and 2015.
1% may feel like not a lot, but when we take into account that it was at 0.05% in May 2021, that’s a 20x higher cost of borrowing for one year for the US treasury and everyone else, too.
The closer we navigate around zero, the smaller changes can make bigger waves in the cost of credit and asset prices.
The 1-month treasury rate remained close to zero, but the 3-month rate spiked from almost zero to 0.35%.
The tide seems to be turning just as US inflation reached 7.48% based on a 12-month change in CPI (February 2022). That’s a level US consumers and businesses haven’t seen since the early 1980s.
As much as we consider ourselves bottom-up stock pickers, we pay close attention to the macro environment we operate in, and both inflation and rising rates have been on our minds lately.
Supply, demand, inflation
In the first half of 2021, we saw supply chain constraints, demand recovery, and inflation gathering speed.
In the second half, supply chain issues continued, but in some segments, we started to see normalization. The demand continued to evolve, too. In some cases (cleaning products among them), it remained elevated but hasn’t grown year over year as much it did in the previous year.
Businesses also faced input cost increases from commodity to labor.
Pricing power came to the forefront of our attention. Can the businesses raise prices, and will the consumer accept it? We’ve been paying more for anything from a basic grocery basket to rent and movie streaming at home.
Inflation has an impact on consumer psychology. When it reaches a certain level, it starts to affect the shopping decisions. Consumers may accelerate some purchases or choose to forego others completely.
We are yet to see how many of the recent challenges are long-lasting and how many will pass as the supply and demand find a new firm footing beyond the pandemic years. The same applies to inflation.
The US economy is still the biggest, healthiest, 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, 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.
What could we have done differently?
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 (3/2022). We often say that what we don’t own matters as much as what we do own.
As much as at times last year we looked back and thought that we wished we had been more invested right away after the 2020 sell-off, we found some redemption in early 2022; we are glad today that we kept our steady course through 2021 and haven’t given in to FOMO (fear of missing out).
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. 2020-2022 markets reminded us how challenging and unpredictable the markets could be. They convinced us further that patience and caution are the best way forward.
Happy Investing! | Bogumil Baranowski | Published: 3/16/2022
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.