Put A Bow On It. This One Is Done
It’s been a humdinger of a year on Wall Street. We began the year in a world with perpetually low-interest rates and high technology. Interest rates had been at rock bottom, at least since the great financial crisis of 2008, and we thought that would last indefinitely. Most of the well-established investment themes fell this year.
While the one area of real growth in the market was the high-tech companies, market leaders: Apple, Amazon, Microsoft, Meta, and Alphabet would always lead the way, or so we thought when 2022 began.
Things began to go haywire early in the year when Russia started its Special Military Operation in Ukraine. NATO and nearly all of Europe got their hackles up and took immediate umbrage at this cross-border war. Suddenly everything was a kilter.
A month after fighting broke out, President Biden cut off all Russian oil imports. Thus began a series of events from which we’re still recovering. The Russian “sanctions” lead directly to incredibly high inflation. According to the Bureau of Labor Statistics, which keeps track of such things, gasoline has been the number one contributor toward inflation.
And just like that, one of Wall Street’s fundamental themes of low inflation and low-interest rates was gone. Biden let the inflation genie out of its bottle with the stroke of his pen.
For the Street, this action halted the longest-running bull market in history. The bull market in bonds began back in the 1980s. For nearly four decades, the most reliable of all trades has been to go long with bonds. As the long decline in inflation prevailed, bond investors benefited from their bond interest coupon, and capital appreciation as the decline in rates drove bond prices higher.
But the go-long-with-bonds mantra ended as quickly as the Federal Reserve could say rate hike.
The next major investment trend to end this year was the always-reliable big tech stocks. For as long as most traders can remember, investing in the big five tech stocks has been the most reliable path to capital gains. As we pointed out in another article, the higher interest rates hurt these big tech stocks. Not because they needed help making the new interest payments. Most of these companies have little to no debt. The problem lies with the investors in these stocks. Primarily Hedge Funds, Private Equity Funds, and various other pool investors. Many of these funds utilize leverage to make their investments, and the higher interest rate made that more expensive.
So the selling in big tech that began earlier in the year got underway big-time by the end of the third quarter. From then on, we’ve seen some tremendous declines as investors liquidated. Most notable have been the declines in Amazon, down 50% in value, and Facebook/Meta, down 70%.
Investment managers like to use the term “rotation” to describe this market behavior. Often this is a gradual, slow-moving change in market leadership. But not this year. This year the rotation took on the attitude of a Cat 5 Hurricane. As Fund Annual Reports are written, we’ll see just how devastating all this has been for fund shareholders.
But Mr. Market wasn’t done just yet. In perhaps the most brutal of all ironies, the most hated of all sectors, the oil companies, were for nearly half the year the best-performing group.
That’s right, “Big Oil,” perhaps the most politically incorrect of any group of companies, was the biggest beneficiary of the high inflation. All that oil, sitting beneath their feet, went up and up in value. The price of oil spiked on news that Biden was cutting off the Russian supply. From just over 70 per barrel in January, oil went to more than $123 per barrel on the “sanction.” Suddenly the value of all those oil companies’ “proven reserves” nearly doubled. And oil company stocks became the best-performing group in the market.
For Investment managers, all this has them spinning. Fund and portfolio managers have been trying to catch up with all that’s happened. If there’s one thing a professional investment manager does not want to be stuck with, it’s a “dog stock” at the end of the year. Because the entire portfolio is immortalized in the annual report come December 31. In contrast, investors may ignore the many trades last quarter. They pay close attention to the fund’s final investments come year-end.
So much of what you’ve been seeing over the past month is “Window dressing.” Investment funds, selling their poor performers, and repositioning. Poor performers? That’s easy. Get rid of Amazon and Meta in the big five. They have the worst performance of the group.
But where to put those funds? Ah, that’s the hard part. The inflation play might drive you to buy more oil companies. But, as you and I have talked, inflation is beginning to fade. Indeed, oil stocks are not performing as well as they did earlier in the year.
What is gaining some notice on Wall Street is the increasing specter of a significant slowdown in the economy, perhaps even a recession. Several major banks are calling for a weaker economy by the third quarter of 2023.
And you know, one of the best investments in hard times…are bonds.
And the circle completes.
The third and final estimate for GDP and Corporate Profits was reported by the Bureau of Economic Analysis this morning. After processing this batch of data, the BEA concluded that the economy was slightly more robust than its previous estimate.
GDP increased by 3.2%, up three ticks from their previous estimate, while Corporate Profits increased by 8/10%, better by six ticks than the previous estimate.
So, we head into 2023 with an economy estimated to be slightly stronger than earlier estimates. But with woeful profits. And, after all, profits are the principal driver for the Stock Market.
In earnings so far this morning, positive results for HR company, Paychex, and glass company Apogee Enterprises. However a significant drop in the used car company Carmax.
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