I Like Pie, but not Humble Pie
I hope everything is well and you are looking forward to 2023. A lot of water passed under the bridge last year and the economy and market should get back on track by year-end.
During the fourth quarter of 2022, the S&P 500 Index gained 7.1%, the NASDAQ Index lost 1.0%, the Russell 2000 Growth Index gained 3.9%, and the iShares Barclays 7-10 yr. Treasury Bond ETF (IEF) was down 0.2%. For 2022, the S&P 500 Index lost 19.4%, the NASDAQ Index lost 33.1%, and the iShares Barclays 7-10 yr. Treasury Bond ETF (IEF) lost 16.7%.[1]
In 2022, the returns of the major market indexes were dismal to say the least. What made matters worse is that bond investments did not provide a safe haven to invest. Stocks and bonds both had negative returns.
In 2000, when the internet bubble burst, the S&P 500 lost approximately 30%, but bonds rallied and offset some of the stock market losses.
In 2008, when the housing bubble burst, setting off the Great Financial Crisis, the S&P 500 lost 50% of its value during the ensuing 18-month bear market, but bonds rallied and again mitigated diversified investor’s stock losses.
In addition, 2022 was an interesting year as many were eating humble pie, a figurative serving of humiliation usually in the form of a forced submission, apology, or retraction.
A few key factors are:
Throughout most of 2021, the Federal Reserve Board committee continued to promote an accommodative economic policy saying higher inflation is temporary and not a problem. Today after many interest rate increases, they are eating pie and cautioning that monetary policy is likely to stay restrictive for some time until real signs of progress emerge on inflation. This means interest rates will likely continue to increase.
Others are FOMO investors: this group includes novice to highly sophisticated investors who succumb to FOMO (fear of missing out). These investors simply take on a momentum-based strategy which does not concentrate on financial facts and figures. This momentum strategy has been coined as MOMO and focuses on stocks that are rising in value on increasing daily volume. As the stock market rocketed up from the easy Fed money policies many investors embraced a MOMO strategy as an easy way to make money and touted their gains. In the past year, many investors are eating Humble Pie due to their losses as many of these MOMO investments have fallen even more than the indexes.
This strategy can be very dangerous since the economics of the investment are largely ignored and there isn’t a leg for the investment to stand on when the story sours. Since many investors can’t admit they were wrong and sell when the momentum turns, they hold, or even worse buy more of a losing proposition. Recent examples of losing MOMO investments are Beyond Meat, Peloton, Snap, Snowflake, and Zoom. Even large darling companies have lost their MOMO and are well off their highs, leaving many investors with losses. Examples are Metaverse, Nvidia, Tesla, and Netflix. These are good companies, but they became overpriced as MOMO investors bought up shares based on the story behind the company and not the financials.
Lastly, President of Russia Vladimir Putin declared many victories after he launched a full-scale invasion into Ukraine last February. As of recent, many of the lands have been taken back by the tenacity of the Ukrainian military. Even very smart tactical people can get it wrong and have to eat pie.
The reason I bring up Humble Pie is that many people have been caught off-guard for one reason or another. Being overly committed to one’s own ideas can lead one to ignore key facts and result in a negative outcome.
The key to good investing is fairly easy and intuitive. It’s the vigilance and disciplined application of key principles and understanding the nuances that makes investing difficult.
My overall view on making money starts first with finding a company that is profitably selling more and more of a good or service in the current economic environment. No matter how bleak the world is, someone is making money. Next, I evaluate how the company makes their profits and the likelihood that it can be replicated in the future.
Then, I look at the price I must pay for the expected future profits. An analogy would be, a Mercedes is a great car, but if the sticker was $1 million, it’s not a great deal.
Lastly, I look to see how the company fits into the current market environment. Does anyone care and is it participating in the market in a positive way? Just as there are fad stocks which are way overpriced, there are profitable companies which can be ignored for great lengths of time. A good example of this is investments in clean water. For decades, the availability of clean water has been an issue, and there are many companies serving this need, but these investments have largely been ignored by Wall Street. As of today, I don’t have any water-based investments, but when the markets begin to reward those companies with higher share prices, I will take another look.
I foresee 2023 could be a challenging drawn-out year for the markets as the Fed tackles the inflation issue. Fed Chairman Jerome Powell recently stated that short-term data can be deceptive, and he needs to see more consistent evidence before altering the Fed’s course. This to me is kicking the can down the road and avoiding taking a hard stance on attacking the issue of continued inflation.
The Fed historically has been poor in the timing of their acceptance of inflation, recessions, and the length of their remedies. My guess is they will continue too long with their restrictive interest rate policies which will result in a recession. Recessions result in lower corporate earnings which in turn cause stock prices to fall. Earnings expectations by major financial institutions are finally coming down and being reflected in lower stock market prices.
My prediction is that in the first part of 2023 the markets will be volatile as investors are being swayed by media headlines about the magnitude and length of the Fed’s restrictive interest rate policy and the length and depth of a recession. Later in the year, I predict the economic situation will be clearer and the stock markets will rebound. The economy may be in a recession, but since stock market prices reflect the expected future value of earnings, it can begin to recover.
Here’s how I see things today:
Positives:
1. The stock market will improve in the latter half of 2023
2. The Fed moderates its restrictive interest rate policy and rates begin to come down
3. The price of oil falls due to the slowing economy
4. The costly Ukraine conflict heads toward a conclusion
Negatives:
1. Inflation is persistent
2. Interest rates won’t peak until after the first quarter causing a drag on the economy.
3. Current earnings predictions are not fully reflecting the possibility of a recession
4. General prices remain high putting pressure on many families to pay their bills
5. Geopolitical unrest continues, especially in the Middle East
In the coming weeks, corporations will be reporting their 2022 results and the management conference calls will give insight into how businesses view their 2023 prospects. This will provide me with a new set of companies to evaluate as prospects for investing in the new economic environment.
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.
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
Securities processed by and investment advice provided through Landolt Securities, Inc. Member: FINRA/SIPC
Torii Asset Management, Inc. and Landolt Securities, Inc. are not affiliated companies.
[1] These returns are priced based and exclusive of dividend reinvestment.