After two historic years with the entire world dealing with the extraordinary ramifications of the Covid-19 virus, 2022 started out seemingly headed down a path towards normalization across global economies. There were hurdles in the way including the still ongoing Covid pandemic, global supply chain shortages, transportation logistics, labor shortages and inflation; but, these were problems expected to resolve over time. However, the invasion of Ukraine by Russia compounded those issues, created new energy and food inflation concerns, and has called into question global leadership, future trade relations and security agreements. Markets reacted negatively in Q1 as interest rates jumped all across the yield curve. As we suggested might happen last quarter, high-growth, high-PE companies were hit hardest (with the NASDAQ down 8.9%) while the S&P500 was down 4.6%. Our focus on quality management teams and strong-freecash-generating businesses held up relatively well, and we expect this to continue in a rising interest rate environment going forward.
The confluence of macro issues today is as complicated as we can remember. The financial press likes to simplify these concerns and draw immediate conclusions as to their impact on market indexes. We believe these short-term, narrow perspectives mislead investors, create even more trading volatility, and generally act to unnecessarily swing investor sentiment over short periods of time.
Our view is that these static perspectives miss the inherent value of a strong management team and proven business in meeting long-term investment objectives. Generally, companies are rewarded with higher stock prices when they grow earnings and cashflow over time; so, good management teams continually adjust their operations to meet long term goals as economic circumstances evolve. Smart CEOs optimize their balance sheets based on their expectations for future interest rates. They manage their workforce to support expected future needs and modify pricing to match current costs with demand. Smart management teams efficiently fine-tune their cashflow and margins as economics and customer demand change. Regardless of recessions and black swan events, many of our stocks have increased their dividends each year for decades. Their management teams make it work in all environments and create real value over time for their shareholders.
Many of our portfolio holdings currently generate record levels of earnings and are forecast to continue to grow their earnings over the next few years. Current valuations appear supported by earnings and are reasonable. We will be vigilant in the pending quarterly report cycle to spot margin weaknesses that suggest a downturn in earnings going forward. Underlying inflation has increased nominal growth which is positive up to a point. We feel that time and the impact of the Fed’s reversal of its QE monetary program will help resolve many of the near-term drivers of inflation.
We at SFE don’t pretend to have everything figured out with respect to how the macro issues play out. But we do expect that long term interest rates will normalize at a higher level once the Fed stops buying Treasury bonds. This, along with near-term inflation trends likely continuing, means we’ll probably see interest rates continue to rise across the curve over 2022. We expect an inverted yield curve will be avoided and do not anticipate a near term recession. With interest rates rising from very low levels, equities remain the best asset class to protect purchasing power and investor capital over time.
Disclosure Statement SFE
Investment Counsel is a Registered Investment Adviser. This presentation is solely for informational purposes and not a solicitation to invest. The results reflect the deduction of fees and the reinvestment of dividends and other earnings. Advisory services are only offered to clients or prospective clients where SFE and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by SFE unless a client service agreement is in place. Please contact a financial advisory professional before making any investment. 801 South Figueroa Street│Suite 610 │Los Angeles CA 90017 │213.612.0220 t │213.612.-0329 f │sfeic.com SEC Registered Investment Advisor