They say the darkest hour is right before the dawn They say the darkest hour is right before the dawn But you wouldn't know it by me Every day's been darkness since you been gone. Bob Dylan-Meet me in the Morning Blood on the Tracks 1975
Like a forsaken lover, investors have felt abandoned.
Accelerating inflation combined with interest rates doubling in six months resulted in a 20% loss for the S&P 500, the worst start to a year since 1970.
According to the Dow Jones Market Data, even the investment-grade bond market, usually a safe harbor in a storm, suffered an 11% loss, the worst in history.[1]
Below you can see the sharp rise in interest rates this year. Interest rates are one of the primary determinants of bond and stock valuations.
Cyclical excess of money, injected into the economy to soften the blow of shutting down the world’s economy in 2020 and 2021, give way to 2022 restrictive monetary policies.
Savers, at least, are finally rewarded with higher interest rates. Investors gravitate to increased cash flow and dividend-oriented companies, shouting, “Show me the money today,” versus promises of tomorrow’s growth.
For 2022, the tortoise (Value Stocks) is catching up to the hare (Growth Stocks), which has been in front for nearly a decade. [2]
However, the faint streaks of dawn to the east foretell a new day, possibly a more fruitful day.
It’s probable that inflation and interest rates may be peaking, allowing the Federal Reserve to reduce its hawkish tone that is scaring the markets. Valuations are more compelling today than a year ago.
A shallow recession may appear during the next six months, but the markets may have priced in the slowdown and now will anticipate the ending of the rapid rise in inflation and interest rates.
The stock market looks forward to the morning sun like a weary night traveler.
Investor sentiment is historically low, a contrarian and bullish signal that may reward patient investors. High food and gas prices are hitting everyone, especially the lower-income population. Consumer confidence is lower than after the September 11 attacks, the 2008-2009 financial crisis, and the coronavirus lockdown.
Consumers’ confidence may go lower from here, but it’s worth noting – according to JP Morgan, the average 12-month return of the S&P 500 after the eight consumer sentiment troughs since 1971 was 24.9%. [3] In addition, the second year of the four-year presidential cycle is typically challenging for the markets. The mid-term election usually resolves the uncertainty that drags on the markets.[4]
BlueBird’s strategies continue to overweight energy and commodities. These positions helped our portfolios until a dramatic decline in energy and commodity stocks in late June. We remain bullish on the energy sector, especially the US pipeline infrastructure companies, which are needed to increase our exports. These companies are finally generating significant free cash flow after a decade in the desert.
The global balance between energy supply and demand may not be resolved at lower prices soon. As China eases its restrictive Covid measures, energy demand will follow.
In addition, Russian sanctions, ESG green mandates, and shareholders all put pressure on new investments into energy projects. Without additional investment, the industry will be under intense pressure to meet the global demand. Global oil demand is over 100 million barrels daily, yet OPEC’s spare capacity is shrinking. [5]
Natural gas is equally in solid demand globally, with the US uniquely positioned to supply the world, especially in Europe and Asia. The low energy prices of the past decade are rising worldwide, no more dramatically than in Europe, where natural gas prices have skyrocketed to nearly 10x what we pay in the US.[6]
Already Germany is putting in place measures to limit the use of natural gas.[7] More Liquified Natural Gas (LNG) capacity is needed to bring US natural gas to Europe and Asia. US companies engaged in energy production and transportation, their employees, communities, and shareholders, all stand to benefit.
BlueBird Advisory main strategies use a combination of active stock managers combined with a passive approach. In addition we use alternative strategies such as real estate and managed futures along with bonds to diversify the portfolios. Despite the diversification, most portfolios were down as the relentless selling continued into late June.
Our main value manager, Pacer US Cash Cows 100, COWZ is a low-cost, tax-efficient strategy fund. Their strategy owns companies with higher than average free cash flow but at a low valuation. The focus on free cash flow targets companies highlights business models that favor intangible assets such as software and intellectual resources versus bricks and mortar. [8]
In summary, after three years of solid returns, the stock and bond market had a sharp six-month correction. This volatility, while rare, is not unheard of and the price we pay for above-average long-term returns. Of course, as we say in our business, past performance is no guarantee of the future.
