- Geopolitics are often the cause of 10% pullbacks in the S&P 500.
- 10% corrections morph into 15% corrections 50% of the time.1
- We think this 10% correction is highly likely to bleed to a 15 - 20% correction at some point during Q2, and hence the S&P 500 to low 4,000/high 3,000 level.
- A major geopolitical issue + bad inflation numbers = Shouldn’t the market be down more than 13%?
- Regardless of the tragic outcome in Ukraine, we have an inflation problem in the US that should continue to weigh on equities, at least for now.
- We do not believe this correction will bleed past the -20% level. Declines of that magnitude historically are associated with recessions. A recession just two years after the previous one would be highly unusual. The three previous bear market (non-recessionary) corrections stopped short of -20%: 1998, 2011 and 2018. Every time, the market subsequently rallied to new all-time highs within 4 months.2
- Investing into every 10% non-recessionary correction has produced an average return of +15% over the following 12 months, even though the market may have become uglier first.3
- The Fed anticipates inflation will subside into the spring. We agree. However, until then, the markets are operating in a vacuum.
- We expect corporate fundamentals will remain stronger than what many bears predict, which was the catalyst for the rapid bull market recovery in the three previous periods cited above: 1998, 2011, 2018.
- We maintain our original 2022 Outlook call. We continue to believe 2022 will be an “ok” year for stocks, consistent with the third year off a recession low. These tend to be characterized by strong earnings, offset by a less accommodative central bank policy.
- If the Fed or geopolitics were going to kill the economy, the two and ten-year treasury yields would be dropping, and there would be far greater stress in the bond market. This is consistent with our view that the US economy has the power to withstand the inflation/external shocks.
- In a rising interest rate environment, value stocks should continue to outperform. We continue to emphasize financials despite the recent hit due to the geopolitical situation. We expect financials will be relative outperformers in a rising yield environment.
- We have recently trimmed back energy exposure and added to financials. Energy is under-owned but very extended.
- While richly-priced growth stocks have dramatically repriced, rising yields will continue to weigh on these stocks. In our experience, once bubbles pop, they don’t end in “V” bottoms.
- Our portfolios have been underweight in Europe, which looks like the right call, as the risk of a recession in Europe is far greater than elsewhere. However, our global European luxury consumer stocks have been taken to the shed recently. We anticipate sticking with current positioning here, as we have not seen signs of fundamental deterioration in those companies.
- Asia ex-Japan continues to be our biggest non-US exposure and fertile ground for finding out-of-favor stocks that have compounded at very high levels over time. These stocks continue to struggle, given the strength of the US dollar and the current fragility of the global investor especially towards China. Traditionally, the US dollar peaks with the first Fed rate hike.4
There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and may therefore be less than what you paid for them. Market values can change daily due to economic and other events (e.g. Natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. Portfolio liquidity) of events. Accordingly, you can lose money investing in this portfolio. Please be aware that this portfolio may be subject to certain additional risks. In general, equities securities’ values also fluctuate in response to activities specific to a company. Stocks of small-and medium-capitalization companies entail special risks, such as limited product lines, markets and financial resources, and greater market volatility than securities of larger, more established companies. Investments in foreign markets entail special risks such as currency, political, economic, market and liquidity risks. Illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk). Non-diversified portfolios often invest in a more limited number of issuers. As such, changes in the financial condition or market value of a single issuer may cause greater volatility.