The Pessimist curses the winds….the Optimist hopes it will change….
…The Realist adjusts the sails.—William Arthur Ward
There can be no doubt that the seas we are sailing in now look and feel much different than those of the past decade. Should we head for shore and set anchor, waiting for calmer waters and a wind at our back? Or trust the boat we have built and the crew sailing it to tack against the wind and stormy seas right in front of us and chart a course to better conditions on the far horizon?
Each quarter, we study research from many independent investment firms and an interesting thing frequently happens when the seas turn stormy. Many analysts and economists who tend to get increasingly optimistic and recommend going to full sails as the markets climb higher and higher suddenly get a severe case of seasickness and want to head for the harbor.
Those who are generally more pessimistic turn into optimistic and opportunistic realists focused on looking beyond today’s turbulent waters. They position the sails to take full advantage of the opportunities that always appear at the end of a storm.
Which course should we follow? First, let’s examine the headwinds more closely.
These major headwinds arrived much more quickly and with more ferocity than most people (including us) expected and include:
- Inflation- the covid shutdown and our government’s efforts to plug the holes in the economy, combined with the supply chain disruptions around the world, have led to faster and higher inflation than expected.
Higher Interest Rates- the Federal Reserve is admittedly behind the curve in fighting both short- and long-term inflation and has begun to raise interest rates more quickly than the markets expected. Combined with the expectation of more increases to come, this has led to a significant repricing to the downside of almost all risk assets. The Fed is determined to bring down inflation…even if it means we enter recession.
Russia/Ukraine war—is hurting European economies and disrupting global supply chains—most notably in food and agriculture. In addition, persistent COVID-19 outbreaks in China are slowing their economy and distribution chains even further.
Slower corporate earnings—we have said it many times before but it’s worth repeating again—over the long term, there is a direct correlation between overall average corporate earnings growth and stock prices. While the stock market has likely priced in all the other headwinds mentioned above, we don’t believe it has priced in this one and that could mean further declines in stock prices in the short term.
While the extremes of each of these headwinds do give us some cause for concern, they are also creating opportunities to reallocate assets to be in position to potentially benefit from the changed investment world around us. Here are some of the ways we are tacking into the wind:
Dividends- in a slower economy with higher interest rates and inflation, companies which have had enough profitability and cash flow to pay and grow dividends historically been a sweet spot. Specific industries currently being targeted include healthcare, financials, utilities, real estate, and energy.
Bonds - we think the bond market is oversold and see compelling opportunities in higher yielding corporates and, for high income taxpayers, municipals.
Discounted Growth Stocks- there are good reasons why so many high-octane growth companies have seen their prices drop dramatically. However, selling magnified by and tinged with fear and indiscrimination has created opportunities to invest in growth industries which still appear to have a long runway of earnings growth...particularly in the software/cloud computing and healthcare/biotech sectors.
We also remain significantly underweighted to large company global and emerging market stocks.
The overall annualized returns we estimate when projecting long term values have not changed that much. As the stock market provided above average returns over the last decade, we reduced our long-term return expectation but are now increasing our long-term expected return on bonds.
While there is a natural tendency to be optimists in a capitalist economy largely driven by the consumer, we prefer to listen to both sides... but lean in a little closer to the pessimists turned realists as history overwhelmingly suggests that theirs is the better course to follow to the land of long-term wealth accumulation and protection.
All of that said, we understand how difficult it may be to open your quarterly statements with the market experiencing its worst first 6 months of the year in more than 50 years. We also believe that while we may dislike the current prices of your investments, that if they are allocated in anticipation of your need for income over the next 6 to 8 years then collectively, they form a world class boat being sailed by a crew of realists who have sailed through many storms.
Thank you for your continued confidence in and support of our crew and don’t hesitate to reach out to Bert, Brian or Katie if you would like to discuss further.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The economic forecasts set forth in this material may not develop as predicted. All investing involves risk including loss of principal, No strategy assures success or protects against loss. Dividend payments are not guaranteed and may be reduced or eliminated at any time by the company. High yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors.
Municipal bonds are subject to availability and change in price. They are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply. If sold prior to maturity, capital gains tax could apply. Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.