2022 Q1 Commentary

Losing 5% Was Best You Could Do in Stocks and Bonds This Quarter

The above headline is taken from a Bloomberg article [1] written in late March at the close of the first quarter. The following excerpts from this article highlight the challenging environment investors were facing in the quarter.

“Across equity and fixed-income markets broadly, the least-bad performance among U.S. assets were declines of 4.9% in the S&P 500 and speculative credit. They were followed by a 5.6% fall in Treasuries and a 7.8% slide in investment grade. Not since 1980 has the best return among those four categories been so paltry, data compiled by Bloomberg show.”
“The concerted selloff is particularly bad news for the popular 60/40 portfolio strategy that aims to perform well through the benefit of diversification and is widely followed by balanced mutual funds and pensions. A Bloomberg model tracking a portfolio of 60% stocks and 40% fixed-income securities dropped 4.6% as of Wednesday, all but certain to notch the first quarterly loss in two years.”

The one bright spot were commodities which wrapped up their best quarter in more than 30 years. The S&P Goldman Sachs Commodity Index, a benchmark tracking the prices of commodities futures from precious metals to livestock, has climbed 29% in the first quarter, recording its biggest gain since 1990. While this sector was kind to investors, it had the opposite effect on the consumer, which faced rising gasoline, food, and shipping costs. The long-term economic impact of these rising prices will likely not be fully evident until later this year and into 2023.

Things We Are Watching

The Federal Reserve

The Federal Reserve (the Fed) raised short-term interest rates by 25 basis points in March and wound down their monthly asset purchase program (quantitative easing) of U.S. Treasuries and mortgage-backed securities. Many Wall Street investment banks are now forecasting 7 or 8 interest rate increases this year. In addition, Federal Reserve Board Governor, Lael Brainard, who is generally considered to be a dovish member of the Fed, recently stated she believes the Fed needs to be more aggressive in selling down the assets on their balance sheet. It seems the Fed’s current plan is to raise interest rates at each upcoming meeting, with some increases being 50 basis points, combined with $95 billion of monthly sales of securities from their balance sheet (quantitative tightening). These actions will certainly tighten financial conditions and may pose a headwind to asset prices this year. The good news, however, is this tightening has already begun as interest rates across the yield curve have risen rapidly in the last few months. In essence, the market has taken the cue from the Fed and already repriced bonds in anticipation of the coming rate increases. Unless the market has mispriced how much the Fed will ultimately need to raise rates, bond market volatility could begin to ease in coming months.

Geopolitical

The war in Ukraine poses several risks to investors. As has been widely reported, Ukraine is an important producer of agricultural commodities such as wheat. Disruptions in the supply of these commodities may cause food shortages in parts of the emerging world which can lead to social unrest. In addition, commodity prices are likely to remain elevated for a time which will have a dampening effect on economic growth. Western Europe is also facing surging energy prices because of their dependence on Russian natural gas. This will crimp discretionary spending and may lead to a recession. Finally, we don’t know what signals, if any, China is deciphering from this conflict. Does this embolden their reunification goals for Taiwan? One thing is clear. Geopolitical risks are rising, leading to greater uncertainty.

Economic Growth

The rapid rise in interest rates is likely to slow economic growth in the U.S. The Fed is attempting a soft landing, which translates into cooling inflationary pressures by raising interest rates, while attempting to avoid an economic recession. Not an easy task. The yield curve has already inverted, meaning short-term interest rates are now higher than long-term interest rates. Historically, this has been a good, but not perfect, indicator of impending economic recessions. Wall Street veteran, David Rosenberg, is firmly in the recession camp. He recently wrote the following:

“Do we really need to debate the yield curve when the rail, truck, airline stocks have broken down, while recession sectors like utilities and consumer staples made new record highs yesterday?”[2]

The Federal Reserve Bank of Atlanta’s Real GDP Now Indicator is forecasting only .9% economic growth for the first quarter of 2022. A significant slowing from the previous year. Whether this is just a bump in the road or something more significant, only time will tell. But the probability of slowing growth later this year seems to be rising not receding. If the economy does begin to slow, it may cool inflation, leading to a less hawkish Fed which could benefit asset prices.

Strategy

These are challenging times for an investor. After having lived through a pandemic and voluntary shutdown of the global economy, investors are now faced with a war in Western Europe, raging inflation, and a Fed determined to cool the economy to put the inflation genie back in the bottle. We are not macro investors, meaning we do not attempt to invest according to what we think will happen in the world. In our experience, very few investors are successful with this approach over the long-term. Rather, we choose to focus on the things we can control, namely the construction of broadly diversified portfolios populated with resilient businesses that can weather whatever storm may come. This approach has been successful for decades, and we believe it will continue to be.

As always, we appreciate the trust your place in us, and we remain committed to helping you achieve your financial goals.

The opinions expressed are those of PYAW’s Investment Team. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Forward looking statements cannot be guaranteed.

PYA Waltman Capital, LLC (“PYAW”) is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about PYAW’s investment advisory services can be found in its Form ADV Part 2, which is available upon request. PYA-22-10

[1] https://www.bloomberg.com/news/articles/2022-03-31/losing-5-was-best-you-could-do-in-stocks-and-bonds-this-quarter

[2] https://twitter.com/EconguyRosie/status/1512058169853464576?s=20&t=V8FaAu1AMNy6UkbSiNTbxA