Spring Commentary

By TRG Advisors on May 9, 2022

Are We Celebrating May Day, Or Shouting “Mayday!”?

As of the market close on Friday, May 6^th, the S&P 500 was down -13.49% Year-to-date.  In April, typically a good month for equity markets, The S&P 500 posted a decline of -8.8%, the worst month since March of 2020 (you know, when the world sort of . . . shut down). So far, 2022 has shown some of the worst equity performance in decades.  That’s scary.  That hurts.  It stinks.  If you don’t believe me, just turn on one of the financial channels and they’ll be more than happy to tell you how bad things really are.  Remember, bad news sells a lot more than good news, or even more than “less bad” news.  The idea is to keep you worried and paying close attention to the next bad thing they’re about to tell you, just after this next commercial break.

Going back to the S&P 500, which of course is what everyone lives and dies by (insert note of heavy sarcasm there), it closed last Friday, 5/9/2022, at a level of 4,123.  Now, let’s play a little guessing game:

Pretend we’re talking on one of either of those May days in the past (we very well may have, or you can go back and read what we were writing).  What if we said two years ago on 5/8/2020 that we had no idea what would happen in the coming months, but if there are breakthroughs in vaccinations, we could see a rally in the equity markets?  Sound familiar?  Now, we didn’t know just how well the equities were going to perform, but the message was to stick to your guns (or allocation in this case).  What if we said we expect volatility, but equities could be up over 40% in two years, what would you want to do?

What if we said a year ago on 5/10/2021 that equities are pricey, we expect to see volatility, (sound familiar?) and that at some point (we don’t know when) a year from now the S&P might be up a lot, or might even be -1.6% lower than it is today?  Would you have wanted to exit the portfolio?

The point from which you measure your expectations matters.  If you are basing your feelings about the market by looking at its drop from a high to a low, you are bound to be disappointed.  Market highs can be temporary, but they’ve always been beaten by new highs.  Market lows can be really concerning, but they’ve always been temporary.

What we’ve been saying for quite some time is that we have been expecting to see an increase in volatility, and that against a backdrop of lower-than-normal volatility over the past several years, it could seem very dramatic and scary.  What we have seen so far this year from the equity markets is actually very well within the range of normal.  Going back to 1980, the average intra-year drop of the S&P 500 is -14%.  (Again, note we’re down -13.49% as of this writing).  Despite this, the index had positive returns 32 out of 42 of those years.

To be clear, we are not saying all things are rosy.  We are in precarious times and there are lots of moving pieces.  We have high inflation as a result of excess liquidity in the system, high oil prices, and supply chain disruptions.  The war in Ukraine has exacerbated the oil price increase and disrupted supply chains beyond what we were already experiencing from the pandemic.  Inflation has spiked dramatically, and the Fed is on the path to raise rates and reduce its balance sheet.  Mortgage rates have jumped quickly from the 3% range to the 5% range.  Bonds, which usually provide some stability in times of equity declines, are also down year-to-date due to the rising rate environment.  Thankfully, alternatives such as commodities, real estate, hedge strategies, and private investments have done well so far this year.

So where do we go from here?  Are we headed into a recession?

First, let’s define a recession.  Technically, it is at least two consecutive quarters of decline (or negative growth) in our Gross Domestic Product (GDP).  But apart from the technical definition, a recession is the working off of excesses in the system.  Recessions are typically associated with elevated unemployment, falling incomes, and slowing wholesale and retail sales.

For those of you that might have missed it, the GDP number for Q1 of 2022 was -1.4%.  However, we don’t expect Q2 to be negative.  In fact, we think it unlikely we will see a recession in 2022, or even early 2023.

It is clear the Fed is committed to raising rates in an attempt to help dampen inflation and remove stimulus from the economy.  But this is not the only factor impacting the rate at which the economy will grow.  The higher price of oil acts as a tax on the consumer, especially for those at lower income levels who spend more of their income on fuel.  While many homeowners were able to refinance their mortgages at historically low rates, new home buyers are now having to readjust their expectations on home affordability with rates 50-60% higher than when they first started looking.  Higher prices of products will have an impact on demand, and the increasing costs of goods and services will eventually cause the consumer (the driver of most of our economy) to pause and perhaps adjust down their spending.  The US Dollar is strengthening (the US Dollar Index is close to its 20-year high), which makes our products less competitive overseas. 

Will energy prices suddenly drop and help alleviate some of inflation worries?  We think it unlikely any time soon as the war in Ukraine continues.  Will the US Dollar roll over and start to decline?  Given current global economics, the dollar is likely to stay strong and the world’s reserve currency.  Will the Fed suddenly reverse course and either pause rate hikes or even cut rates?  We expect a rate hike at the next two meetings, and then we’ll see how those other factors have impacted economic growth.  Will assets become so cheap that investors jump in to purchase at reduced prices?  Currently it is hard to argue that there is an easy slam-dunk option for finding undervalued assets.  All that being said, there is still potential for a “soft landing.”

In the short-term, there could be more pain to come.  But inevitably, economic forces always end up bringing things into balance.  Unemployment is still very low.  Both corporate and consumer balance sheets remain in good shape and do not show signs of excess leverage.  While goods and services are growing more expensive, post-pandemic demand remains robust, particularly for business and personal travel.  Despite the impending economic slowdown, there will always be good companies that are run effectively, make profits, employ staff, and return capital to investors over the longer-term.  We remain engaged and are evaluating shifts in portfolios to best position for upcoming trends.

As always, if you have questions or if there have been any material changes to your financial outlook, we encourage you to reach out and we’d love to set a time to talk.

Wishing you good fortune,

Paul

_{Sources:
FactSet
Bureau of Economic Analysis
Gavekal Research
JP Morgan Asset Management}