Between a Rock and a Hard Place

The Federal Reserve is stuck between a rock and a hard place.  Since the Great Financial Crisis, the Fed was able to implement expansionary monetary policies without having to worry about inflation.  The market took its cue from the Fed that bad times could be fixed with lower interest rates and asset purchases. Covid changed that. 

We can’t put all the blame entirely on the Fed.  Nobody knew how long Covid would last.  That global supply chains would be trampled by swings in supply and demand.  That a slowdown in China could be accompanied by substantial inflation.  Or that Putin would attempt a failed invasion of Ukraine. Yet here we are.

With inflation at its highest levels in 40 years, the Fed has no choice but to raise interest rates and reduce its balance sheet.  They can no longer afford to bail out markets, and asset prices are adjusting accordingly. 

Since the market peaked in November the S&P is down 15%, the tech heavy Nasdaq is down 26%, and “Innovation” stocks as described by the now infamous growth manger, Cathie Woods, are down 66%.  Most of the work from home bunch like Zoom and Peloton are down over 70%.  Even some of the pre-covid heroes, the FAANG stocks, have suffered massive losses with Netflix down 70% and Facebook down 50%.

Nobody was spared from the market’s realignment.  Bonds, the “safe” part of many portfolios suffered double digit losses.   If you bought a 30-year US Treasury bond in November 2021, you’ve now got a 25% paper loss on the safest asset class in the market!

We never like to see our client’s portfolios go down, but there is a silver lining.  By sticking to our value-based principles, we’ve so far managed to insulate our clients from the devastation many of the traders and gamblers are seeing in their portfolios.  We’ve still suffered losses, but by remaining diversified, avoiding the over-hyped momentum stocks, and holding onto the much-maligned energy sector, we’ve taken some of the sting out. 

Our bond portfolios also show small paper losses, but in buying short-dated maturities, higher interest rates have had a smaller impact.  We expect most (hopefully all) of these bonds to pay us back in full at par over the next few years, negating the negative short-term return.  That gives us choices.  We can reinvest the proceeds at higher yields, rebalance portfolios without having to sell securities in volatile markets, or provide cash for clients living from their investments.  The same can’t be said for that 30-year Treasury investor. 

The best part is great companies are finally on sale!  That is something we have not been able to say for a long time (aside from a 2-week period in March of 2020). 

There are two things we are confident about.  The first is that the volatility caused by a Fed that has no choice but to raise rates into a slowing economy is far from over.  The pain felt in liquid equity markets will eventually spill over into private markets.  Venture capitalists need to decide which of their unicorns (private companies worth over $1 billion) will survive.  Private lenders will realize why banks were happy to let others make the riskiest loans. Higher mortgage rates will likely bring the housing market back to earth, and there will probably be a lot of cryptocurrencies worth nothing.     

That leads us to the second.  When the market hits the flush button, it usually takes down the good with the bad.  Our job over the coming months will be to see through the noise to take advantage of this.  We’ll be selling our expensive stocks and buying what the markets have given up on. We’ll never guess the bottom, but we remain confident in the long-term ability of our companies to generate profits and cash flow despite the global economy adjusting to a new reality of higher inflation and slower growth. 

It’s important to remember that we’ve developed an asset allocation for each of our clients to prepare for the inevitable market correction.  Over the last 75 years, the stock market has declined by more than 10% 41 times (Source: Guggenheim).  It’s an inevitable part of owning stocks.  To survive, we must persevere through the turbulence, and use it to our advantage.  We’ve done it for our clients for decades, and we are confident we will do it again. 

_{Compass Wealth Management LLC is a SEC registered investment advisor, clearing transactions primarily through Pershing Advisor Solutions and Pershing LLC subsidiaries of Bank of New York Mellon Corp. This letter is written by Compass for the benefit of its clients and does not necessarily represent the opinions of its affiliated organizations. It is based on information believed to be reliable, but which is not guaranteed to be correct. Nothing herein shall be construed to be a solicitation to buy or sell securities, indicate that past performance is predictive of future returns, or recommend individual investments.}