After two big up years, the market has begun 2022 on a down note. This is how markets work: two steps forward and one step back.
There are indeed things to worry about: inflation being number one, with the cost of living is rising at the fastest rate since 1982 (although in 1982, inflation was heading in the other direction). Covid is not going away; Russia is about to invade Ukraine; and China’s economy is now growing at only 4 percent as economic freedom is losing out to communist rule.
There is plenty to worry about, so what is an investor to do? The first thing we have to do is remember what we are supposed to be doing. We don’t invest in politics, or even economies; we invest in companies – specific companies.
The reason prudent investing is always done from the bottom-up is because there is always something out there to worry about. The glass is always half empty, which means it is always half full. Inflation is high because demand is high, and companies are able to raise prices. While that is painful to consumers, it is good – or at least appears to be good – for company financial reports. I say appears to be good, because it isn’t real, it is simply inflation, but businesses will report higher earnings nonetheless. That will ultimately lead to higher stock prices.
Inflation has this effect for most businesses, which is part of what is driving the market. Underneath the surface what we are really seeing in the beginning of 2022 is a rotation out of the fast-growing technology stocks that have driven the market for a decade and into under-appreciated value stocks, such as financials and energy. Through Friday, January 14, the value indices – Russell 1000 Value and Russell 2000 Value, representing large and small companies respectively – are the only positive major domestic indices.
This transition really began towards the end of 2020, but markets do not move in straight lines. Mid-way through last year the old-guard technology stocks made a comeback, but the longer-term trend is still towards value. This bodes well for small company stocks, international stocks, and just about any area of the stock market that hasn’t participated in the last decade of growth.
Still, the overall direction thus far in 2022 is going the wrong way. One never knows exactly what the market will do, and it could continue this downward pressure for a while; however, we believe this is simply a rotation. It would not be surprising to see lower returns in 2022 than over the last few years, but we would be surprised if the market does not end the year in positive territory. Meanwhile, lower prices are an opportunity.
Two steps forward and one step back is the normal market rhythm. We never really like it when we take the step back, but look on the bright side: how many times have we been able to say “this is normal” over the last few years?
Warm regards,
Chuck Osborne, CFA
Managing Director
