Stroll Cocoplum Balancing Act of New Bull Market
BALANCING ACT OF THE NEW BULL MARKET- IS IT TIME TO THINK OFFENSE?
By: Mason Williams, Managing Director & Chief Investment Officer & Michael J. Unger, Vice President of Investments & Planning
The first half of 2022 was a difficult period for investors, as financial markets rapidly adjusted to a less accommodative Federal Reserve policy and a softening global economy. Other than crude oil and several commodities, nearly all major asset classes posted significant declines, with many entering bear market territories. The S&P 500 experienced its worst first half in fifty-two years with a -20% return. This year has been characterized by a decline in market valuations as equities have adjusted to higher interest rates. While recent economic data has illustrated a technical recession for the U.S., the employment report showcased the strength of the labor force with the addition of half a million workers and an unemployment rate at a historical low. Both stock and bond markets rallied in the late summer months as investors have been encouraged by corporate earnings that showed a less bleak picture than originally feared. Currently, the expectations for earnings growth in 2022 and 2023 are 9% and 8%, respectively. If this growth rate proves accurate, this is a relatively healthy backdrop for stocks. While we are not out of the woods, it is welcoming to see inflation slowly declining from peak levels.This is very important since price declines for food and energy have a direct influence on consumer pocketbooks and behavior. Ultimately, improving economic indicators will provide relief to the consumer to maintain their demand and ability to support the economy.
With the benefit of hindsight, we can see that the enormous fiscal and monetary stimulus in response to the pandemic resulted in lingering economic imbalances. Most notably, with the number one enemy being inflation. The presence of historic high inflation is the reason for the Federal Reserve's change in policy to focus primarily on aggressively combating inflation by accelerating interest rate hikes. Although, this has caused market turmoil, the Federal Reserve's intension is to fulfill its mandate of maintaining price stability. One can debate the appropriateness of
current federal reserve policy, since these are the same officials that were confident that their previous actions would not create rampant inflation. When inflation did appear, it was dismissed as "transitory". Our view is that the Federal Reserve did miscalculate the impact of its actions and waited too long to act, leaving the economy in a vulnerable position. However, rather than rationalizing the rapidly changing economic data, policy decisions have now been made to fight rising prices. This is the path we are on today - experiencing short-term pain in exchange for longer-term stability and economic growth. While there will likely be more months of interest rate hikes, we suspect that a story for the remainder of the year will be how quickly inflation retreats as tighter financial conditions take hold.
Historically, during periods of market corrections, investors have typically looked to fixed income as a source of relief from volatile stock price declines. This year that has not been the case, as the dramatic rise in yields has led to disappointing returns with many corporate bond investments down double digits. The steep drop in prices was driven by a combination of higher Treasury yields and rising credit spreads, as markets adjusted to hotter
inflation readings and hawkish Federal Reserve. Where yields go from here will likely depend on the inflation outlook and how aggressive the Federal Reserve's response will be. It is important to note that after the steep drop in prices, yields on many corporate bond investments are near their highest levels in years creating an opportunity for savers.
This is an important time for investors to avoid becoming overly negative about the future and remember the long-term wealth creation potential of the equity market. As Warren Buffet has said about the markets and investing in general: "be fearful when others are greedy and greedy when others are fearful." Now that speculative excesses have been purged from financial markets, it is time to look for value in asset classes that have sold off
creating a positive risk/reward scenario as we are one step closer to the next bull market. One of the biggest opportunities in the market today, is the very low bar for a positive surprise in corporate earnings or guidance. Expectations for corporate earnings have been reset lower with further price declines in securities widely expected. It is well known that the most money is made in markets when conditions go "from bad to less bad". While we never know the absolute bottom in advance, history tells us that the best companies are adaptable, efficient and have weathered storms in the past only to come out stronger. As always, our focus remains on high-quality equity and fixed income investments, particularly those of companies with consistent earnings, pricing power, and the ability to return cash to shareholders.This year has produced several important portfolio
considerations including: 1) Reallocating to have a proper growth/value balance; 2) Increasing duration in highquality bonds to lock in higher coupons; 3) With small caps at the cheapest they have been compared to large cap, it is time to increase allocation to smallcaps 4) Increase the global allocation as international exposure remains an important component within a diversified portfolio; 5) Perfect time for an overall portfolio review; 6) With Roth IRA Conversions "On Sale" it might be time to utilize this strategy. At the end of the day, having a well-built diversified portfolio is a solid step towards financial freedom but having it run in tandem to a detailed financial plan will ensure success in reaching one's long-term goals no matter what market environment investors face.
For more information please contact:
Mason Williams, Managing Director & Chief, Investment Officer
Coral Gables Trust Company
255 Alhambra Circle, Suite 333
Michael J. Unger
Vice President of Investments & Planning
Coral Gables Trust Company
255 Alhambra Circle, Suite 333