2022Q2 - Quarterly Review & Market Commentary
8min video
In today’s video, we will review how markets have performed over the last quarter, changes we’ve made to portfolios for some of our clients, provide some historical perspective, and the keys to the market finding a bottom.
Video Transcript:
In today’s video, we will review how markets have performed over the last quarter, changes we’ve made to portfolios for some of our clients, provide some historical perspective, and the keys to the market finding a bottom.
As always, with these end-of-quarter videos our clients may or may not have positions in the securities discussed as each investor’s goals vary – if you’d like to discuss your specific positions please reach out. If you are a client, you will be receiving a separate email detailing your specific, individual performance. Also, I typically try to keep most of my videos shorter, but obviously, there’s a ton going on right now and a lot to cover, so this will be a little longer than normal.
Here we can see various market metrics from Blackrock, ranging from oil to the broad equity markets in the US. The Orange bar shows the year-to-date range in price and the yellow dots reflect where market levels were as of last week on June 24th. There haven’t been many places to hide this year, but that does not mean there aren’t potential opportunities with the amount of negative consumer sentiment weighing on all markets.
At the end of the day, the only thing the stock market cares about is future expected corporate earnings. Generally speaking, what we’ve experienced so far this year is a contraction of this future expectation. On this chart, we can see the forward P/E or price-to-earnings ratio back in January peaking at around 23 times earnings. At the end of May, the multiple was sitting around 17 on S&P 500 with the long-term average near the same number. So what the market in a broad sense has done, is with all the uncertainty out there, simply compressed this multiple more in line with historical norms.
So I see this, and I wonder, alright, we’ve pulled back on the forward P/E, how do markets typically perform going forward with a P/E where we are sitting right now?
On the X-axis we have the forward P/E and on the y-axis, the subsequent 1-year returns on the left, and 5-year returns on the right since ’97. If we were to draw a line through this data as a ballparked average, what this tells us, is that on average the lower the forward P/E the higher the subsequent returns. So if we slide to the left on the x-axis and lower the p/e the subsequent returns on the y-axis tend to increase on average.
So that’s great to know, but what we all are wondering is, what will be the true drivers to the market bottom?
Well – there are three significant issues impacting markets right now.
1. Lockdowns in China - Just recently has China begun to ease its zero-covid policy with new infections under 100 a day for almost two weeks. While most lockdowns have been lifted, it will take a while for supply chain constraints to work out.
2. Russia-Ukraine Conflict -This is obviously hurting growth, and stoking both inflation and oil prices.
3. 40-year high inflation - Central banks are facing a growth vs inflation tradeoff right now. Hiking rates too much risks triggering a recession, while not tightening enough risks causing runaway inflation. The Fed has made it clear to the stock market that it is ready to intentionally dampen growth. Time will tell how much dampening will be required to stifle inflation.
Resolving these three issues will be the key to the markets finding a bottom and restoring confidence. Any investor that can say with certainty how much worse it can get, and when the selling will stop is only demonstrating their investing acumen. Because over the short run, markets will continue to be volatile. Instead, I think it’s important to take a minute to zoom out and maintain perspective.
Here, we are looking at the worst years ever for the US Stock Market. The key to focus on here though if you are a long-term investor is the 3 and 5-year columns. The average 3year return is 35%, and the average 5year return is almost 80%. Remember, you don’t get high returns without the possibility of low returns on occasion. It’s not a bug, it’s a feature of the stock market.
Peter Lynch has a famous quote, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections than has been lost in corrections themselves.” The takeaway is to stay in the game and stay the course.”
That said, we aren’t sitting on our hands either. Let’s shift now and review some of the tweaks and changes that we’ve made for some of our clients over the last quarter. Again, this is not intended as specific investment advice as each investor, including our own clients may or may not have positions in the securities discussed. Also, forewarning, this part of the video will be pretty heavy on the financial jargon, so please reach out if you’d like to discuss it further.
Alright, so earlier this year, with the expectation of more persistent inflation we proactively put on positions in commodities and energy, just a quick screen grab from yahoo finance shows how COMT (a broad commodity ETF in the dark blue) and XLE (a broad energy ETF in the light blue) have performed year to date. For some clients, we were able to lock in portions of these gains during the last quarter and used the proceeds to introduce exposure to US infrastructure and dividend-focused companies which have historically delivered attractive relative returns during periods of tightened financial conditions. We also reduced overall sensitivity to growth and more volatile assets by cutting net exposure to technology and small caps. Flipping over to the bond side of the portfolio, we increased exposure to inflation-protected US treasuries or TIPS, which potentially provide less downside if long nominal rates rise further while providing a hedge against any further potential upside surprises in inflation. One final overall theme, we’ve implemented is the future prospect for governments to continue on their net-zero emissions climate journey. Politics aside, climate risk and subsequent legislative risk do translate to investment risk regardless of political beliefs. Right, so I don’t want to make this about politics. The market doesn’t care if it’s red or blue, just if it’s green. The narrowing window for many governments to reach net-zero goals means that investors could consider adapting their portfolios today. The net-zero journey is not a 2050 story; it’s a now story. And because of this, we favor equity sectors better positioned for the green transition.
I realize I covered a ton during this video in a short amount of time. For my clients, also I realize many of you will be receiving quarterly performance reports with lackluster returns, to say the least. Please know that I’m keeping an eye on things and that I’m here to talk.
As always stay the course, and stay on point.
