Three Minute Digest for July 1, 2022
The S&P 500 has recorded its worst first half of any year since 1970. It is down -20.58% for the year while the tech heavy Nasdaq is down -29.51% for the same period. On average, our Affinity Capital Portfolios are down just over 13% with a sizable percentage of our weakness occurring this month as our holdings in the broad energy sector fell more than -18% the week of June 13th. We added this particular position in September of last year and have enjoyed a more than 50% gain until this month. Should this position drop below our watch area, we will determine whether to sell and lock in our remaining gains until we get more clarity on the sector.
We expect volatility to continue into the new quarter and our portfolios maintain their highest levels of cash since 2008. This cash is extremely valuable. While we cannot time the market exactly, we will seek opportune times to reinvest.
The concerns about inflation continue to be the dominant theme for investors although a laundry list of concerns abounds. This includes Covid related slowdowns in Chinese manufacturing, supply chain disruptions, microchip shortages, worldwide commodity & food shortages arising from Russia’s invasion of Ukraine, the applications of Norway and Sweden to NATO with the potential to further inflame an irrational Russian leadership and an aggressive Federal Reserve policy to fight 40-year high inflation combined with a slowing economy.
The Federal Reserve raised the federal funds rate by 0.75% this month and the current expectation is for another 0.75% hike at their July 26-27 meeting. We have mentioned numerous times in our comments that the economy will typically experience either inflation or recession but not at the same time. While the US economy has not reached the quite simple technical definition of recession as being two consecutive quarters of economic decline, as reflected by GDP (Gross Domestic Product), we believe we are safe in saying we are there in all but name. Now add surging inflation and a behind the curve Federal Reserve trying to play catch-up. We have concerns that they will overshoot the mark of monetary policy actions and deepen the hole we are in. With that said, opportunities will be created over the next couple of quarters and years, and as long-term investors we remain optimistic. We think it helpful to revisit a selection from a past Affinity Capital Digest:
Stagflation:
The purpose of raising rates is to slow down rising inflation which is traditionally a result of a rapid economic growth cycle. Our view is that current inflation is less the result of a traditional business cycle and more the result of an overreaction to the pandemic by flooding the economy with trillions of dollars in government support, supply chain disruptions and spiraling gas prices. Meanwhile, we have recessionary indicators indicated by publicly traded companies reporting lower earnings, lower profit margins and less than optimistic business projections going forward. This combination of economic factors is often referred to as “stagflation” and this creates confusion about economic activity going forward. As we have often mentioned, markets like predictability but the conflicting economic measures and statistics of an uncoordinated business cycle creates market days like today.
With the end of the second calendar quarter comes “earnings season.” Public companies will announce their financial results and the markets will take great notice. Inflation dampens the value of a company’s earnings and therefore makes stocks less attractive to investors but a reaction to this may be more attractive income opportunities. We remain alert.
As always, please feel free to call with any questions. We are here for you.