The first 4 months of 2022 have been bad for markets, historically bad.
The worst for the Nasdaq ever
The worst for the S&P since 1970
The worst for bonds since 1980
2022 was always going to be a consolidation year. Rates needed to rise, supply chains needed to reorganise and economies to rebalance back to a mixture of goods and services as the pandemic restrictions lifted.
Inflation was too high, but the signs were for a moderation throughout the year to a less concerning 3.5-4%.
Then came the Russian invasion of Ukraine followed by another China COVID lockdown. In the space of four weeks.
These together added significant additional disruptions to oil, gas, metals, grains and supply chains. Prices rocketed creating the perfect storm to fan the inflation fires. The numbers for March and April became scarily high at 8% plus and central banks started talking aggressive rate rises. Not that raising interest rates will do anything to reduce gas prices, but they are mandated to keep a check on inflation and interest rates are their only tool.
As we have often observed, interest rates are pivotal to the pricing of risk assets and sharply rising rates are a poor environment for investors generally.
So how bad is it?
Well plainly it’s been pretty horrendous recently but with a longer term view I think it’s reasonable to look at things with a little less gloom.
From 18th February 2020 when the pandemic hit, the portfolios were up between 15.56% and 24.35% to the 31st December 2021. This was in some ways ridiculous if one considers that we struggled through a global pandemic and resultant economic maelstrom. It was made possible by huge central bank money printing. As we wrote about previously, inflation was predicted by most economists post-financial crisis (2008) and never happened even though there was massive QE. This time it did happen because people were locked in, given free money and spent it on goods which were scarce due to pandemic created supply disruptions.
This was a temporary phenomenon and reasonable to expect equilibriums returning to most markets in 2022/23. If you think in terms of being given steroids to get through a tough time and then needing to come off them, this created some transitory withdrawal symptoms. Given how bad things would have been without the economic steroids this seemed a price well worth paying.
It was also to be expected that markets rebalanced with less hype around pandemic induced winners or losers and a return to focusing on longer term profitability. The frothy parts of markets were at the edges. SPACs, crypto and NFTs were always likely to deflate as we were saying last year but the portfolios had no direct exposure to any of them.
So, it’s I think fair to say that the Ukraine war and another Chinese lockdown have exacerbated a period which would have been a bit uncomfortable and morphed it into something properly painful.
Valuations
The technology sector has taken a beating with valuations down 22% for Apple and 93% for Peloton (from the highs between 18th February 2020 and lows on 12th May 2022).
There were some silly high prices for a time especially with COVID related stocks like Peloton, but the earnings reports of quality tech companies are mostly still excellent, and valuations are now attractive.
As an example, Alphabet (Google) earnings just announced were up 20% plus and they are an elite player in the fastest growing areas of tech including cloud computing, digital advertising, AI and driverless vehicles.
They just announced a $70 Billion share buyback and the shares trade on a P/E ratio of 20. If the cash it holds is excluded it would be around 18. This now looks compellingly attractively priced; growth is higher than the earnings multiple which is itself only the market average. Google is not just a market average company.
Assumptions in the market
The three items currently haunting global markets are
- Inflation
- Russia/Ukraine
- China COVID lockdowns and supply chain disruption.
The common element to all three is that the prevailing market view is deeply negative.
Inflation will continue at current levels or higher. There is no end to the war and the resultant disruptions. China is in a terrible mess and will stay in one.
In fact, various investor sentiment surveys over the past few weeks are producing amongst the most negative results ever seen, as bad or worse than the depths of the Great Financial crisis.
Just consider for a moment that:
- It is quite possible that the peak inflation readings have already been seen. Some of the elements causing most inflation such as second-hand cars and wages are moderating fast. Inflation doesn’t stay high unless prices keep going up. The rising interest rates and demand destruction from the negative wealth effect of falling asset prices will dampen demand. The cure for higher prices is often higher prices which reduces forward demand
- The effects of the war are known, and supply chains are being realigned. The war appears to be recalibrating to the Donbas region of Ukraine, the area originally assumed most likely to be annexed
- The Chinese COVID situation is as bad as it can get so it’s really a question of when it starts to get better and how much stimulus China then throws at the economy when it does
The reason it appears so dark currently is we are at peak disruption and uncertainty. This is the time to deploy capital to buy great assets at sale prices, but one major distinction must be drawn from the recent past in this regard:
The central bank has got our back?
The conclusion to this piece will be a positive restatement of reasons to invest generally and in certain market sectors specifically for potentially outstanding longer-term returns.
But plainly something important has recently shifted in relation to Central Bank monetary policy and this must be acknowledged.
The inflation rate in the 2010s didn’t rise even when monetary supply was engorged which to most economic historians was thought impossible.
This led to many assuming meaningful inflation was dead. The long-term trajectory of Western economies was with low growth and low interest rates.
So, there is a new element to be factored into macro-economic projections; re the Central Banks going to be far more cautious going forward with stimulating economies now that inflation has reappeared? (Is the Fed Put less powerful).
Did they become overly confident due to the lack of inflation in the 2010s?
It appears probable that the answer to the above are all yes.
Conclusions
The reality of the value of a company share price is profit. What does it earn, what will it earn? Prices paid for shares over some periods will be excessive or undervalued but over time the truth is earnings, and they will dictate the valuations.
There really is no excess valuation left in market valuations. The shares of growth companies have been smashed and some will go on to be hugely valuable businesses and this will be the “wow, you could have bought X for that in 2022” moment. Equally some will never get back to previous highs.
The stock market is behaving like the economy is in the dumpster, but the current reality is consumption is strong. There is no excessive debt, consumers have historically healthy personal balance sheets and job opportunities are plentiful. In addition, spending on services is super robust as people start to do the things they could not in lockdown.
It’s so important to remember that downturns are quick and violent. They feel horrible as they happen but there have been hundreds previously and markets recovered and grew to new highs each time.
On average through the last 100 years there has been a 10% market correction annually and 20% correction every 27 months.
The portfolios are packed with the best companies globally.
As James Anderson recently said:
“It is almost certain that just one company owned by the Scottish Mortgage Fund will grow to a value in the fund greater than the total value of the whole fund today”.
If you would like to discuss any portfolio related matters George and I are available to you.
Note: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog, and the reader should accept that by its very nature many of the points are subjective and opinions of the author. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.