At the beginning of the year, we wrote that 2022 was likely to be a challenging year, but that one should not get too negative during market selloffs. That turned out to be even more true than we realized as the market was down as much as 13.5% for the year before rallying sharply in March. Our process still suggests risks over the next few months remain elevated. Just as it was inappropriate to panic after two bad months to start the year, it is now inappropriate to be complacent after the recent strong rally. On balance however, the market picture is more clear and risk/reward more favorable than it was three months ago.
- Valuations were stretched coming into the year. They have contracted as last quarter’s earnings results were very strong, prices have come down somewhat, and estimates of forward earnings have increased. The stock market is not cheap, but it is attractively valued compared to bonds.
- Fed policy was a big uncertainty coming into the year. Market participants have digested the shift in Fed policy, and are currently pricing in a total of 7 rate hikes this year. The market has increased clarity here.
- After three exceptionally strong years, the market needed a pause to recharge itself. Though our indicators suggest more time is needed, the past three months are a good start.
- The uncertainty from the economic transition from goods to services remains. This transition implies some slower growth and some economic turmoil, though the weight of the evidence suggests the economy should remain resilient in coming quarters.
Much has been written about the rise in commodity prices, particularly oil, and the risk of it causing a recession. We disagree. Incomes have risen over time. At current oil prices, the share of consumer expenditures on gasoline is comparable to the 2012-2014 period, and far below numbers that preceded recession in 1980 and 2008 (data from Fundstrat). Furthermore, S&P 500 profit margins have historically been positively correlated with higher commodity prices according to data from Credit Suisse. Lastly, we remind people that the increase in commodity prices has benefitted many accounts directly as our process caused us to add energy and commodity-related companies for most client portfolios before their dramatic rise in value.
The market absorbed a lot of bad news in the first three months of the year, and it showed its resiliency. We previously wrote “market pullbacks will be good buying opportunities but it will not feel like it in the moment”. We added stock exposure for most clients during the late-February selloff. Our objective indicators suggested it was appropriate, even though it didn’t “feel” comfortable at the time. In addition, our process kept clients away from hard hit areas of the market, such as European stocks and many technology stocks. As always, we will continue to follow our tactical, objective, and differentiated process going forward.
CSG Capital Partners