The 2nd Quarter of 2022 firmly pushed markets into Bear Market territory. With the S&P 500 scoring its worst first six months of a calendar year since the early 1970s, Carderock stocks are down (-25%) on average. At this stage, Quality’s virtues in moderating stock declines have yet to show their mettle – but they will. We strongly believe the companies we invest in will remain buoyant and come out on the other side intact and positioned to do well in the next cycle. In the meantime, the Federal Reserve’s rate increases have crunched the resilience of bond values such that a portfolio balanced with a 55%-35%-10% (Stock-Bond-Cash) allocation fell approximately (-15%). This, too, will pass.
Unlike the “Pandemic Panic” of March 2020, there will be no rush of fiscal or monetary support headed our way, leaving investors largely dependent on the mix of their wits and patience to ride it out. Many suggest the Fed’s narrowly reactive stance will fail, ending either with a shift to a more broadly grounded approach, or as history and the data suggest, cause a recession. In either case, the likelihood is that higher rates embed additional costs, cut growth, and prove ineffective at curbing supply-chain related inflation. Given this prospect, we see the glimmer of a silver lining in a few places:
- Markets – Speculation has been curtailed, and capital is being utilized more efficiently.
- Technology – Decades long advancements in processing speed have sown the seeds for high-level automation and artificial intelligence, which will boost productivity.
- Labor – Participation and wage growth remain strong, though re-training in certain segments of the economy will take time.
- Production – Logistical and supply constraints are easing, with high inventories stimulating price cuts.
- Policy – Infrastructure upgrades incenting investment over financialization will spark growth in new industries.
Furthermore, we believe we are getting closer to a turn in the markets, and our investment strategy focus is on the following:
- The first half of the year saw narrow leadership in stocks, with Energy the only positive sector year to date.
- Shares of Quality Growth have been disproportionately punished relative to their strong future prospects. We expect a very robust recovery.
- We continue to rebalance toward a more even-weighted portfolio, capturing losses to offset heavy realization of gains earlier in the year.
- While the bulk of our stock positions remain intact, we will add a few new positions as trends shift and develop in the next economic cycle.
- The bottom line is that with 30% cash reserves, we have a store for defenses and ultimate redeployment, as rebounds inevitably comes more rapidly than expected.
- Bonds prices fell in tandem with stocks as the Fed aggressively hiked interest rates during a period of slower economic growth.
- With a flat yield curve, short maturities offer attractive values.
- Similarly, municipals offer compelling returns relative to taxable bonds of similar maturities.
While it has undoubtedly been a rough start to the year, we remain optimistic that a turn is in the offing, and U.S. Growth stocks will once again prove out. Good times do in fact follow bad, and sure as we’re currently being tested, the best fruits of recovery will accrue to those who remain invested, and continue their participation.
As always, feel free to give us a call to discuss any changes in your objectives, circumstances or with any questions you may have.
Daniel A. Kane, CFA
James W. Mersereau, CFA
Stephen F. Knapp, CFA
Director of Research and Quantitative Strategies