Market Commentary for the week of July 18, 2022

 Divergence

“Two roads diverged in a snowy woods……”

As the economy ponders in which direction the vectors will move next it is incumbent upon us to remember that any period of uncertainty is always a volatile time in the markets.  Of course, the specifics of the variables are much less important than the overall trend itself, which means that one’s macro view of events is more highly significant than trying to micromanage individual inflection points.  “Two roads diverged”…  is more than just a poetic metaphor….it is a warning that needs to be heeded.

Many parts of the global financial landscape are dealing with instability and social crises.  Corporations are caught in the foment, both internal and external, wreaking damaging effect upon their labor force and hiring practices, costs, inventory development, and delivery systems.  Those that can absorb these variables will emerge robust and competitive. Unfortunately, we are also seeing the demise of businesses that are outdated or incompetent and which have difficulty adapting to the commercial disruptions caused by war, Covid, inflation, and supply chain issues.  The nature of competition is that you cannot “protect” the vulnerable and still maintain integrity in the system.

Not in dispute, however, is that the financial system is having difficulty adapting to many factors not of its own making.  Central banks’ efforts to reign in inflation and reduce the money supply is an artificial impingement upon the natural order of things.  Any effort to combat runaway pricing pressures by raising interest rates only prolongs the cycle of discontent.  Rising prices, although onerous, cause the consumer to reduce his purchasing, leaving rising inventories, and resulting sometime later in a reduction of prices.  Such cycles, if interfered with by central authorities, cause greater dislocation than if left to be resolved by the free market.

No matter the industry, there are disruptions occurring to the bottom line in a post-Covid world.  Job number one is always to stay  in business.  So no matter the cause we are seeing more companies trying to be nimble and unfortunately focusing upon the here and now in lieu of strategic planning for the future.

However, we would suggest that there is too much  aggression and emphasis upon managing the short term.  How much fat can be trimmed before irreparable harm is caused to one’s brand, one’s internal organizational structure, or one’s community?  Globally integrated entrepreneurship has gotten so “micro” that the most important thing considered in most boardrooms today is quarter-to-quarter viability and how to appease Wall Street analysts.  True capitalism is being impeded by that kind of thinking.  The withdrawal of the consumer has put business on the defensive.  The reduction in discretionary spending and the lack of confidence in the future has shifted the business culture from expansion and reform  to perish or becoming extinct……and, of course, no one in the boardroom is seeking the latter option.  The loss of a true predatory climate has softened and diluted today’s capitalism to a “bail out” quotient that makes irrelevant a company’s product or mission statement.  Indeed, it is social consciousness, not social justice, that produces a fair market.  Individual users and producers have a much better understanding of the demand/need curve than do central bank engineers who take all the spontaneity out of the economic cycle.  As the upcoming “earnings season” unfolds we expect to see more carnage and more accounting calisthenics to weather the storm.

This is so prevalent as a socioeconomic phenomenon that even with fiscal and monetary support behind them businesses and households would rather withdraw from the contest than try to get in and possibly fail.  Untold billions are not  being spent (where once they were) because of fear about politics, war, migration, ecology, inflation, and such.  City boulevards might be teeming now with people in the wake of the Covid pandemic but there is still an underlying concern about endemic  issues such as hunger, poverty, crime, homelessness, and lack of empathy.

We have recently been using the fortuitous rate increases to dabble in short term time deposits, thereby establishing “baseline” floors to our portfolio returns while reducing volatility associated with concentrated equity positions.  There are no indications that the market has established equilibrium at its bottom quite yet, so we welcome the chance to deploy cash reserves into yield enhancing opportunities for the time being.

Market Commentary for the week of July 1, 2022

$2.60

The emerging shape of a fractured global order is signaling a vigorously unpredictable period ahead for the financial markets.  One’s capacity to withstand brinksmanship over national disputes, international conflict, and standard kitchen table threats will be severely tested in a post-Covid recovery.  Indeed, the aftermath of the recent pandemic, worldwide, is not yet fully understood…economically, politically, or socially.

Thus, taking a macro view…although much harder to do…might put into context some of the fear and anxiety that currently grips the markets.  Depending on how you choose to read the signals, one could conclude that the world is either teetering on the edge of a moral and economic crisis, or that the elements of any optimism for the future also encompass the predictable push/pull of emotions which characterize any secular outlook.  Our view is that the latter is more persuasive; the sky is definitely not  falling.

Markets

A pragmatist looks at the world and tries to make sense of the myriad kaleidoscopic images all around him.  He realizes that he personally doesn’t cause  the various arguments for or against trends, but he sees the logic in them nonetheless.  He recognizes that a multiplicity of factors can be accelerants to recent developments.  That pragmatist, too, would be in a state of shock over the many components that are aggressively in flux right now.  It would take a mapmaker and a soothsayer to make sense of today’s drama.

It is unrealistic to believe that there is a center of origin for all the world’s influence, whether it be one nation, one continent, one leader.  Therefore, we must first eliminate the pretense that all of the globe’s issues originate with one purpose: to stifle the resiliency and success of mankind.  No doubt, we are in a world in turmoil, both political and financial.  History has taken us there before.  But what makes today unique…at least in our lifetime...is a breakdown in tolerance and empathy.  Today, one’s birthplace and ethnicity is an implied Scarlet letter.

It should come as no surprise, then, that economic and market stability is also being affected by those same intolerances.  Labor markets are highly stressed, capital is tight, and strategic goal-setting is more highly influenced by fear, jingoism, and geography than by need.  The stable Western alliances are flourishing while the emerging markets are left to figure it out for themselves, making their fortune and future much less clear.  Industry in those regions cannot even think about 5 year plans because of political and financial instability.  Weather, too, is a factor that has adversely affected farming, construction, and population migration.  Given these developments, fewer corporations are willing to lay down a bet on 19^th and 20^th century -style rules.  And so the poverty and neglect long imbedded in those archaic populations dooms the whole process into oblivion.  The consequence of being poor feeds into a never ending spiral.

However, we must accept that no industry or person is disconnected from the plight of everyone else.  While it is sometimes said that all matters are “local”, it is the attention we pay to the less fortunate, less well established, that could shift the paradigm from dispassion and egotism  to profitable in a heartbeat.  Attitude and empathy should be a line-item on every balance sheet.

“Lean and mean”  has become a corporate euphemism for “we can’t afford to lose market share to the other guy”.   It is an archaic depiction of a me-too era in which competition and profitability meant destruction of all forces standing in your way.  Today, that kind of thinking only evokes an intransient chorus from the well-off who don’t give a darn about anything but their own bank account.   “Not my problem”  is a phrase that can only be uttered by those who already have what they need.  Consider that the “other” guy or woman once started out with the same potential as everyone else.

More and more, the market is fixated upon the near term costs inflicted upon the economy by shortages in product, price spikes, the supply chain, and profitability in the next two quarters.  The dilemma for policy-makers is whether to step on the brakes aggressively or to “tap” on them sporadically.  Post-Covid induced inflation is an aberration from historical norms and might require a new calculus.  For certain, there will be short term downturns in earnings, output, and expectations but there is no doubt that market forces will sort them all out.

A demarcation of sorts was crossed at the end of last quarter when market selling and pessimism became “reactionary” to the Federal Reserve’s pronouncements regarding their intentions to raise rates beyond the 75 basis points already enacted.  In effect, what had been “known” previously became a catalyst for those determined to exit the stock market to run for the exits.  Sometimes it is easy to make money in the markets, other times it is difficult.  The key is knowing how to discern the difference and having the discipline...mental and methodological….to withstand the obstacles.

Strategy

The war in Ukraine, along with China’s health-related (Covid) shutdowns, has exacerbated global supply chain issues.  As noted above, those effects are being felt harshly in the emerging markets, where natural resources are less plentiful and self-sustaining industries are harder to find.  One of the unintended consequences of Russia’s war has been to strengthen political and financial alliances amongst nearby and neighboring countries which now enables them to share in the responsibility of distributing food, oil (energy), and other necessary product.

We see multiple sectors that are experiencing heavy selling pressure despite the fact that they are irrationally linked to stagflation and economic recession.  For example, the food and agriculture industries are poised for extraordinary profit growth in the half-decade ahead, particularly after the inflation and interest rate data is digested by analysts.  A few weeks ago these shares were dropping precipitously along with the rest of the stock market despite the fact that guidance forecasts were strong and these industries fill a pressing global need to feed the hungry.  That is an encouraging sign because other businesses in the socially responsible realm such as energy, healthcare, biotech, and ecology are similarly poised to “fight the tape” and move higher in spite of the pressure current events impose upon their progress.  While there most certainly will be market drift in the upcoming weeks our expectation is that prices will stabilize before the end of the year in these sectors.

We also welcome the efforts by central banks to raise interest rates (tighten the money spigot).  Higher yields will finally inspire an alternative investment scenario in which clients might have the choice to lock in a return from the fixed income markets while also having the option  to speculate in the equity markets.  If the ultimate objective of our policymakers is to overpower price inflation and excessive spending, the unintended consequence of tighter money could be to secure baseline capital appreciation and portfolio income for investors not pleased that the stock market had been the only game in town for the previous decade.  We believe that consumers want to see that type of restriction on superfluous discretionary exorbitance, and let the market cycles play out in an orderly effort.  In fact, it is the absence  of oversight and structure which has created the current inflation/stagflation predicament.  For the first time in years, “order in the court” might impose a consistent macro framework for the financial markets.  

Conclusion

The best way to muddle through challenging economic times is to maintain a strict budget, to focus upon the wider macro aperture, and to hold on to competitive asset allocation guidelines.  Risk and reward are obviously unique to each individual but an approach that considers those tolerances is inherently more successful than jumping from method to method in an effort to outmaneuver potential volatility.  There really is no intrinsic strategy that works for everyone except the one that produces results consistent with your own expectations.  Sometimes, being on the sidelines is not the best choice for the long term success of building one’s net worth.

This upcoming quarter, especially, presents unique challenges.  Two years ago, a flourishing global economy shut down because of Covid.  One year ago, product demand began to increase as the world slowly emerged from its pandemic cocoon.  Today, there are fewer goods and services available to fill the pent-up need, thus inflation is widespread.  Remember, no one was driving a car, flying in an airplane, or eating out in restaurants during the lockdown.  As a result, employers laid off employees or closed up shop entirely.  Now there is a “shortage” of gasoline, repair workers, certain services, and airline pilots. (In reality, those shortages are more related to delivery and supply chain bottlenecks than a dearth of product).  You demand “cheaper gasoline”, but what you really mean is to have a sufficient supply to meet your needs so that you don’t have to pay more for the article of trade.  In so many instances…from healthcare workers, to truck drivers, to dock workers, etc...the situation is onerous and pervasive and not likely soon to end.

Our portfolio resolutions are to remain significantly diversified amongst asset classes so that our minimal stock exposure (roughly 20%) neither precipitates a magnitude of portfolio decline nor proves excessively bold; our fixed income capacity reflects current opportunities to upgrade yield; and our cash reserves provide a bulwark of support that both limits our downside and remains nimble enough to deploy at the appropriate inflection.     

Suggested balanced account asset allocation, Q3, 2022

Equity:                 21%

Fixed Income:     41%

Cash:                   38%