It'll Leave a Bad Taste in Your Mouth
I hope everyone is well and safe. The last quarter was quite ugly with the stock markets in upheaval and an unprovoked war breaking out in Ukraine. At one point the NASDAQ index was down about 20% before it raced back in the last couple of weeks to a loss for the quarter of 9.1%.
During the first quarter of 2022, the S&P 500 Index was down 4.9%, the NASDAQ Index lost 9.1%, the Russell 2000 Growth Index was down 12.7%, and the iShares Barclays 7-10 yr. Treasury Bond ETF (IEF) was down 6.5%.[1] The only place to hide this quarter was in commodity-based assets which did well due to shortages and inflationary pressures.
In this quarter, investors are consumed with the ongoing worries about inflation, the speed and magnitude of rate hikes coming from Federal Reserve monetary policy, global energy prices, and geopolitical fallout from the Ukraine/Russia crises. At the beginning of the year, the Federal Reserve Chairman, Jerome Powell, was continuing to bet that inflation was transitory and Fed officials gave forecasts showing the expectations for the unemployment rate to drop to 3.5% with inflation tumbling from multi-decade highs toward the central bank’s 2% target. At the same time, the projections showed policy makers do not anticipate raising their key interest rate even as high as their long-run estimate of 2.5% for the benchmark.
The key for investors is to understand the effect of inflation and interest rates on their lives. It all boils down to purchasing power. Purchasing power is the amount of goods and services that can be purchased with a unit of currency. It is important because, all else being equal, inflation decreases the number of goods or services you would be able to purchase.
These days, very few people are truly self-sufficient and don’t have to deal with making purchases and competing against all others interested in the same item. Since most prices are based on supply and demand, what matters more than the actual price is that a person has more currency than others wishing to buy an item.
Durian Fruit
At the end of the quarter the Fed still espoused that the economy and labor markets were strong, and they had things under control. That’s like selling the Durian fruit above to an unsuspecting customer. Although it may look okay on the outside, once you peel back the skin, it’ll leave a bad taste in your mouth. Just like so many things in life, what looks good on the outside is not what you find on the inside.
Despite the stock markets strong comeback at the end of last quarter, taken by many investors as strength and an opportunity to buy-the-dip, investors should be vigilant in understanding the change which is taking place.
The Fed has recently changed their statements to give way to raising rates by 0.5% in multiple meetings going forward while the 10-year Treasury rate versus the 2-year rate has briefly gone negative or inverted. In the past, all recessions have been preceded by this inversion, but luckily not all inversions have been followed by a recession. The yield curve is something I am watching closely.
In this kind of environment, areas of investment opportunities will change to accommodate this new environment of higher interest rate and inflation, Fed tightening, energy and supply shortages, and global political risk.
Here’s how I see it today. Cash will be king when things settle down and the immediate minor loss of purchasing power shouldn’t be an overriding concern, considering the current market risk.
- Keep some cash on hand
- Don’t be a yield hog and go for long bond maturities. The principal risk is too great.
- Have some exposure to commodity-related investments to mitigate inflation risk.
- Reduce exposure to the large past stock market winners. These companies may be good at what they do, but their prices to growth rate are still too high.
- Watch for companies that are successfully growing in this inflationary period and are not priced too high in relation to their prospective growth.
How all this plays out will be very interesting since we will be adding in the mid-term elections in the fall. That distraction may be compounded by a possible recession if the Federal Reserve falls behind in tackling inflation and has to become very aggressive with interest rate increases. When a person recognizes a loss in purchasing power, the psychological benefits of the “Wealth Effect” disappears and discretionary spending will likely fall.
As I said in my previous letter, I expect there will be pockets of opportunity for disciplined investors, but it won’t be an easy year.
This market commentary is provided by Martin Yokosawa and Jeff Batterson at Torii® Asset Management. We would like to get your advice on how to make these letters as valuable as possible. If you have any suggestions, please email us at jb@toriiassetmanagement.com. You can also learn more about Torii® Asset Management and view past letters at www.toriiassetmanagement.com.
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Very truly yours,
Martin L. Yokosawa
Torii® Asset Management, Inc. Landolt Securities, Inc.
9S040 Stearman Drive, Naperville, IL. 60564
Copyright Martin L. Yokosawa. All Rights Reserved
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[1] These returns are priced based and exclusive of dividend reinvestment.