In our January letter, after remarking about the wonderful 2021 results for stocks, we delineated a handful of concerns facing investors in the New Year including: 1) inflation, 2) tightening by the Federal Reserve, and 3) geopolitics. Of course, we did not anticipate the war in the Ukraine nor its lasting ramifications. All of these factors, particularly the last item, have led to a correction in the stock market during the first quarter which reduced last year’s gains by less than a third.
As we look ahead, it is clear that there will be more interest rate hikes by the Federal Reserve in the coming months, but we believe there will be no recession. Some are even forecasting a cut in rates a year and a half to two years from now, thereby engineering a so-called “soft landing.” We believe stock markets are influenced primarily by two things: Earnings and Psychology. As we write this letter, we are in the midst of the quarterly earnings season. The results continue to be exceptional and, in most cases, better than expected, as the US economy continues its post-Covid recovery. The psychology has turned negative and investors have become increasingly nervous and confused given the front-page news. We consider this development to be healthy and even positive. As the saying goes, “markets go from euphoria to despair and back to euphoria.” This creates the opportunity to make money by being a contrarian.
We’ve mentioned in previous letters the shifts within the market from growth to value stocks and we have favored stocks that would benefit from somewhat higher inflation. The sectors that have done well this year underscore this point. They are: Energy, Pharmaceuticals, Real Estate, and Materials. These sectors have the ability to pass along price increases to their customers/consumers. The worst performing sectors have been technology, communications, and consumer discretionary stocks.
