Dear Valued Client,
Well, here we are in 2022, and so is Covid. Ugh. What a roller coaster!
This time last year, we came in to 2021 believing that the newly developed vaccines would put this thing behind us. We gained hope when vaccines became available, then lost hope when a large portion of populations did not take the vaccine, then regained hope when hospital deaths declined, then lost hope again when the Delta variant emerged, then regained hope when warm months arrived, then lost hope again when Omicron emerged, then gained hope when death rates from Omicron were found to be lower, then lost hope when we discovered that prior therapies such as Regeneron, are not effective with Omicron, then regained hope when data shows that boosted virus victims are 90% less likely to end up in the hospital or emergency room if they get the Omicron variant!
I’ll take a breath.
2021 Markets in Review
After and during this wild ride, the financial markets did really well. Interest rates stayed stable, unemployment came down to 3.9%, and the overall economy grew at a decent rate—even though we often couldn’t find products on the shelf.
Tech stock, such as Google and Microsoft, did very well along with superstar chipmaker Nvidia. Because these stars are such a large part of the index calculations, indexes such as the S&P 500 appeared to do very well, even though most of the 500 stocks in the index did not. Also lagging were so-called re-opening stocks such as cruise lines and airlines, because of the roller coaster covid year described above. We kept asking ourselves, Are we re-opening or not?
Here is a summary of major indexes:
Dow Jones Industrial 30 Stock Average + 18.8% 9.2%
S&P 500 Stock Average + 27.0% 18.3%
Utility Stock Sector 14.0% - 0.6%
Technology Sector + 29.5% 44.0%
Corporate Bonds, mid-grade + 7.1% 4.7% (includes income)
In light of a historical average of 10-12% annual gains in the S&P, you can see from above that we have had a very good ride, especially in the technology, over the last couple years. If we have taken a couple steps forward, are we due for a step back--maybe even a big step back?
And don’t forget, if your portfolio did not rise by what the stock market did, you probably did not have all stocks in your portfolio, but rather a combination of stocks and bonds.
Here we go again. Our seasoned investors have been through this before. After that wonderful year, we enter the harsh winter of January 2022 where, as of this writing, the S&P is down 7% and tech stocks are down 12%--in just 25 days! Nvidia, one of our core stocks and one which many of you own, illustrates in extreme this up and down: In 2020, the stock rose 106%, then in 2021 rose another 125%, but in the last 25 days has dropped 25%. But still a very nice ride up.
Why all the fluctuation in January? Obviously, part of it is a feeling that there was too much stock price growth in some sectors, like technology last year and the year before that, and investors were taking some chips off the table. And, as inflation lingers on, the Federal Reserve indicated that they would be more inclined to raise interest rates that they charge to banks. If interest rates are higher, corporations have higher interest expenses, people borrow and spend less, and bonds become more attractive compared to stocks. All of this lowers stock prices.
While inflation is frighteningly high, many experts still believe it is a temporary result of reopening the economy after the Covid shut down, a situation in which the Federal government printed lots of extra money chasing fewer products caused by supply chain bottlenecks.
Stock investors have lingo for downward trends in the stock market. A 10% drop is called a correction. A 20% drop is called a bear market. In anticipation of or during a recession, the market typically goes into bear territory and even may drop as much as 25%--or more. As indicated in earlier newsletters, the market comes back, not 50% of the time or even 75% of the time; the market comes back and rises above its pre-drop levels 100% of the time.
It’s easy to write a newsletter and say a correction market is a drop of 10%, but if you own a stock portfolio of, say, $500,000, that’s a $50,000 drop. Ouch. A bear market will be a drop of $100,000. Big ouch and downright scary.
It’s interesting to note that in all the talk from the Fed and financial gurus about higher interest rates and lower stock prices, nobody is talking about a recession. That’s very unusual and may reflect the strange times we are in, in which unemployment is so low, labor shortages abound, and the government is spending money wildly. In light of this, the experts believe we can quiet inflation and keep rolling along without a recession, officially defined as six months of negative economic growth.
Contrary to many experts, I continue to believe that the Federal Reserve is not as concerned about inflation as they give verbiage to. Chairman Powell at his last 2021 press conference carefully alluded that this inflation is caused by temporary re-opening issues. Indeed, if he thought inflation was a serious problem, he could have raised rates at his January meeting, but he did not. He keeps indicating raising rates is on the table, and then the markets react negatively, which may be one of his real motives: reduce the heat of the stock and real estate markets by threatening to take the punch bowl of low interest rates away from the economy.
Investment Sectors Performance Rotate from Year to Year
One of the most difficult concepts to accept by nonprofessional investors is the concept of sector performance rotation. This refers to the historical fact that different investment sectors in the economy perform differently relative to other sectors from one year to the next. That is, in one year, tech stocks may do better than utility stocks, but the next year, utility stocks will beat out tech stocks. Similarly, healthcare stocks may be stars for two years, then the following two years, be the least performing sector.
This concept is not intuitive because we naturally believe that if something is superior, it will always be superior: If Tom Brady was great last week, he’ll be great next week. Unfortunately, stock sectors do not behave like this. Investors go in trends, buying a sector strongly in one year driving up its prices, perhaps too much, and then the next year, the same sector may drop down to a more reasonable price level. Meanwhile, something that was a sleepy stock or sector last year, looks more attractive to the market the following year.
When we hear this explanation, it sounds logical and you may wonder why I even talk about sector rotation. But, so many of our clients with stocks and stock funds ask me to sell a perfectly good stock or fund because in one year or even a three-month period, it has not done as well as other stocks in the portfolio. They ask, “John, Marriott stock did not go up this year, but Square stock rose 247%. Shouldn’t we sell Marriott and buy more Square?” As it turns out, however, the very next year, 2021, Marriott rose 25% and Square dropped 26%.
Our core group of stocks in our client portfolios has one theme: quality. There will be ups and downs, good quarters and bad quarters, but as long as we believe that quality is there, we will recommend to hold. If we see a quality drain, we will recommend selling it, as we did with Square recently.
What Lies Ahead
When Warren Buffett is asked if he is worried about an upcoming bear market and recession, he responds that he can’t wait until it arrives. When it does, he can go in and buy securities that everyone else is selling in a panic at a discount. We call it bargain buying.
In short, our strategy at Dougherty Investment Advisors is to hold steady, stick with quality, and look for bargains in a declining market.
This is easier said than done emotionally. When markets decline, we want to run. And even more scary than staying put, is reaching out to buy what currently may be a stock of a company that is currently under a cloud of negativity. “John, you want me to buy Marriott Hotels when we’re all stuck at home with Covid?!”
While explaining it to one client recently, I compared it to having the courage to invite the ugliest person in your high school class to the prom, but, hoping that after he or she puts a nice outfit on and cleans up, in the end, you’ll end up having a great time. It takes a little faith—and lots of analysis—on our part. Hang in there through these wild rides.
Wishing you the best of health and a happy 2022.