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Good Riddance!

 

By:  Aaron Anderson, CFP®, CFA, Partner & Financial Analyst


January 6, 2023

Last year was a rough year, the worst since the financial crisis of 2008, and the seventh worst since before the Great Depression. With inflation running out of control for some items, especially food (over $5 for 12 little eggs!!), budgets have been stretched. Due to that inflation, the Federal Reserve has been raising interest rates more often and much higher than anyone expected. This, in turn, causes higher borrowing costs which eat into a company’s earnings and causes the calculated intrinsic value of a stock to go down in analyst calculations[1]. None of that is positive for the markets.

Looking at the market, everything seemed to have flipped on its head. Growth stocks previously outperformed value stocks but last year, that reversed. This sector quilt breaks down the returns of the S&P 500 by sectors since 2008 [2].

The picture might appear small if you are on a phone or tablet, so I’ll reference colors as well as the sector names. In 2021 and continuing into 2022, Energy (green) was the best sector. Prior to that, it underperformed the overall market (white) in every year but one from 2012 to 2019 and was the worst performing sector many of those years. That’s what happens when you go from oil futures closing in the negative one day in 2020 to some of the highest prices in the last decade.

On the other end of the spectrum, the Technology sector (orange) outperformed the overall market every year from 2014 to 2021. I remember in 2018 chatter on CNBC where the pundits wondered if the tech outperformance of 2017 was done and people should move to other sectors. Looking at the next three years, that would have been a bad idea. For 2022 though, it was one of the bottom sectors [3].

So what is my prediction for this year? As Yogi Berra said, “Making predictions is hard, especially about the future.” I’ve heard predictions by some that we’ll have more volatility to start this year and then things should pick back up toward the latter half of the year. That’s as good of a prediction as any, but I don’t plan on putting much stock in it.

Why not? The average analyst forecast at the end of 2021 for last year was for the S&P 500 to GAIN a modest 7.5% [4]. Instead, we ended 2022 down 18.1%. This is an average of many different predictions from armies of analysts at big financial firms using massive arrays of Excel spreadsheets with tons of data points. If anyone has the ability and resources to get it right, it would be them and they missed by a lot [5].

I don’t bring that up to belittle them since as I said, making predictions is hard. We didn't even expect being down 18%! But there are two long-term predictions that I do feel comfortable in making.

The first prediction is that the market will likely start to recover before the economy does. Unfortunately, we don't know when that will happen. As you can see from the below charts, history shows that the market (dashed blue line) tends to bottom before earnings, payroll, and GDP (the other lines) [6].

As I said in a previous article, the market begins to recover when times feel the worst and then it climbs a “wall of worry” as Wall Street recovers before Main Street feels it. That’s why we don’t try to time in and out of the market. If you sell when things feel the worst and buy when things feel good, you end up buying high and selling low – the exact opposite of what you need to do to make money.

The second prediction is that the market will eventually recover as it always has historically and the good years will exceed the bad ones. The chart below shows annual returns for the market from 1926-2021 [7].

It hasn’t been updated for 2022, but last year would add one more box in the second red column. We can see from the chart that the market rarely (almost never!) ends at the average 8-10% that we use for annual return numbers. As hard as they are to deal with, large up or down years are the norm, not the exception. Secondly, the positive far outweighs the negative. The market is much more likely to be up than down at the end of a given year. Most down years are less than 12% down while most up years are more than 12% up. Other versions of this chart split that last column into two to look nicer, but I chose this one because it's more accurate and makes a point: we’re six times more likely to be up more than 20% than be down more than 20%!

We took our lumps last year and we might take them again this year. I too am tired of seeing red on my account statements. But, we don’t want to make poor investment decisions while the market is down and emotions are high. Long term, I am optimistic about the economy and the stock market. If I wasn’t, we would find other investments for you (and me!)


Before our quarterly holdings discussion, I’ll start with the usual disclosures:

  • While we tend to use a similar investment mix across all accounts held with us [8], you may not hold some of these positions mentioned here – maybe it’s not appropriate for your goals and risk tolerance or maybe you didn’t have funds available at the time and we didn’t want to sell any of your holdings to make some available.
  • This is NOT a recommendation to buy or sell. It is an “after the fact” report of why we hold what we do. There is neither enough information given here to make an informed decision nor anywhere near the amount of analysis we do on our holdings or prospective holdings. You can of course assume that we have positive expectations for any of our holdings, otherwise we would have sold them. Beyond that, what is stated here is a backward-looking report at what occurred, not a forward-looking prediction of expectations.
  • We are long term investors and so what happens quarter to quarter is not something to focus on. Our best performer one quarter might be our worst performer the next, so again, you should not make investing decisions based on what’s discussed here.

Better Performers

  • BA: Boeing had been an underperformer but seems to be putting the 737 MAX issues behind them. With an aging airline fleet, Boeing stands to benefit on replacement orders as one of two major airline manufacturers worldwide.
  • SPG: Simon Property Group is a real estate investment trust that owns A-list, high value shopping malls. The company’s latest earnings report was stellar and they raised the dividend which shows management’s confidence in future prospects. People still enjoy going to nice places to shop.
  • JPM: JPMorgan is a titan in the financial services industry. They have banking solutions to help everyone from large institutions to individuals through their Chase brand. Their CEO Jaime Dimon is considered one of the top CEOs in the country and so JPMorgan is one of our core holdings for the value side of portfolios.

Underperformers

  • AMZN: As you know, Amazon is one of the biggest “online retailers” in the world. I use quotes because they are so much more than that. They have a logistics network to rival UPS and FedEx, they have data centers to rival Microsoft. I’m a bit surprised Amazon made the underperformers list. I think it’s a mix of traders souring on tech, recession fears looming, and them struggling to compare to prior years where people pandemic shopped online.
  • TSLA: Tesla is the premier electric car company and was one of our best performers in the third quarter. The CEO, Elon Musk, decided to buy Twitter and needed to sell Tesla shares to do it. Unfortunately, he has tried to implement his vision at Twitter in a very ham-fisted way, alienating users and advertisers, and causing Tesla’s branding to take a hit. The company also “only” grew 40% year over year instead of the 50% analysts were looking for.
  • MTTR & SPCE: Matterport is a company that makes 3D, virtual reality recordings of indoor spaces with extremely accurate measurements used in real estate listings, home renovations projects, etc. Virgin Galactic is the world’s first commercial spaceline trying to make space travel as ubiquitous as air travel. I put both together because they both suffer from the same problem. We bought them as future-looking investments and the market has soured on companies like these. The stocks fell so fast that at this point, not enough capital would be created by selling them. Plus, we do have high expectations for the future of both of these cutting-edge companies.

New Positions

  • MRK: Merck is a drug company with a well-regarded pipeline. Most intriguing is a joint partnership with Moderna regarding a melanoma vaccine and news that their Keytruda drug paired with chemotherapy showed promise treating gastric cancer. They are cheaper when compared to their peers and the overall market and pay an above market, safe dividend.
  • HSY: Hershey makes chocolate bars and other candy. Even in recessions, people still buy those as they make cheap gifts when money is tight. The company has a history of paying a solid dividend and growing the stock price as well.
  • HON: Honeywell is an industrial company with its fingers in many pies: retail, healthcare, utilities, aerospace, and energy just to name a few. Many industrial companies continue doing what works, but Honeywell is also innovating to position themselves for the future.

Sold Positions

  • IAC: InterActiveCorp was on the underperformer list last quarter and would have been this quarter as well so we sold to put the funds to work elsewhere. Like last quarter, the continuing slow ad sales and rising interest rates has pressured the stock.
  • CRWD: Crowdstrike is a cybersecurity provider for businesses. The company is great and pulling in market share. Our thesis though was that even in bad times, businesses need to continue paying for security, and so the stock will hold up. Unfortunately, because the number of new businesses signing up has slowed and the stock falls into the hated internet software category, the stock price hasn’t held up. Since our thesis was broken, we sold out of it.
  • GM: General Motors is one where the company fundamentals are solid but the market doesn’t seem to care. There is fear that demand for autos will decrease just as parts have become more readily available and so inventories are increasing. Since the stock can’t seem to move, we decided to put the funds to work elsewhere.


[1] Without getting into the weeds, when analysts use a higher interest rate in their time value of money calculations, it lowers the present value of future earnings, cash flows, etc. As a result, the company is deemed less valuable and so is the stock.

[2] The source has an interactive version if you are on a computer: https://novelinvestor.com/sector-performance/

[3] It’s even worse when you consider that they shuffled companies around in 2019 to move some of the tech stocks like Netflix, Alphabet (Google’s parent company), and Facebook into the Communications Sector (light blue) which was the worst performer last year.

[4] Source: https://www.reuters.com/markets/europe/wall-street-strategists-see-more-gains-2022-2021-12-01/

[5] To be fair, I’m sure there were a few bears that called it correctly, but the vast majority of analysts didn’t. And, those bears were probably wrong in previous years when the doom they predicted failed to happen.

[6] Source: https://privatebank.jpmorgan.com/gl/en/insights/investing/eotm/reruns

[7] Source: https://www.jackson.com/static/jwp/pdf/jmv26125.pdf

[8] I say “similar” because we customize portfolios based on differing goals, risk tolerances, and timing of transactions. So, the size of positions and account performance, both in absolute and relative terms, will be different.



 

Content in this material is for informational purposes only and not intended to provide specific advice for recommendations for any individual.  All performance referenced is historical and is no guarantee future results.  All indices are unmanaged and may not be invested into directly.

The Standard & Poor's 500 Index is a capitalization weighed index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. 

The economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Stock investing includes risks, including fluctuating prices and loss of principal.