Wright Cove Capital: August 2022
August 28th, 2022
Heading into last week, financial markets staged an impressive summer rally. Over the course of the prior six-week period, both the S&P and Nasdaq managed to gain back nearly 50% of the losses sustained in the first half of the year. Gas prices dropped nearly every day and unprofitable growth and meme stocks were back in vogue as equity market participants began to bet on the Fed quickly shifting back to the “easy money” days of years past.
This ended abruptly yesterday afternoon following Jerome Powell’s speech at Jackson Hole.
For those whose idea of a good summer read isn’t Fed Policy, here are a few of the talking points from Chairman Powell:
The Federal Open Market Committee’s (FOMC) overarching focus right now is to bring inflation back down to our 2 percent goal. Price stability is the responsibility of the Federal Reserve and serves as the bedrock of our economy. Without price stability, the economy does not work for anyone
Restoring price stability will likely require maintaining a restrictive policy stance for some time.
While the lower inflation readings for July are welcome, a single month’s improvement falls far short of what the Committee will need to see before we are confident that inflation is moving down.
While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.
…We are taking forceful and rapid steps to moderate demand so that it comes into better alignment with supply, and to keep inflation expectations anchored. We will keep at it until we are confident the job is done.
By the time the market digested Powell’s remarks, the S&P 500 fell over 3% and Nasdaq was down nearly 4% on the day.
For those investors with a longer time horizon, the strong words from Powell and others at Jackson Hole this past week should be embraced (if not applauded). If we are to have a stronger economy and sustained corporate profits in the future, inflation must be dealt with and we agree with Powell that in the short term, this will most likely “bring some pain to households and businesses.”
However, we do not feel that “restrictive” policies in the short-term means avoiding risk assets altogether, especially for those with a longer time horizon and a risk profile that warrants it.
We have and will continue to avoid sectors and securities that we feel are most at risk to higher interest rates and restrictive policies – while favoring those companies with strong balance sheets, proven business models, and the ability to gain market share in a down or sideways economy. In rising rate environments, boring can be very good, and staying invested doesn’t mean sticking with what has worked in the past, just because its price is lower than it once was.
Conversely, for those with a shorter investment time horizon and/or a lower risk profile, we have been taking advantage of higher interest rates by dramatically increasing our allocation to short-dated treasuries and corporate bonds, raising cash, and diversifying away from expensive and speculative stocks into value names and sectors that seek to reduce short-term volatility.
Short-interest rates have not been this high since the fall of 2007 and once again T-bills and money market funds are a compelling alternative to bond funds and equities.
Finally, lost in the headlines of, “Dow Down 1000+ Points,” was the ho-hum reaction of the bond market as both 2yr and 10yr Treasury rates were relatively unchanged (and remain inverted) on a day when volatility in the equity market as quoted by the VIX was up 17%. The disconnect between the bond market (which has been pricing in a recessionary environment) and the stock market (which was betting on a quick Fed pivot and the start of a new bull market) appears to be lessening and should lead to more clarity on the direction of the economy and markets in the coming weeks as another set of inflation data is set to be released.
Time will tell if Friday’s move was a one-day event, or the continuation of the bear market that began earlier this year. Our goal is not to make unilateral bets on one outcome or event, but rather to build diversified, client specific portfolios that seek to achieve the greatest return per unit of risk in any environment.
The themes and strategies that we speak about and the positioning we take in portfolios are all customizable to best reflect each of our clients’ own unique goals and should not be interpreted as general investment advice.
As always, if you have any questions or comments – or would like to hear more about Wright Cove Capital, please fee to reach out.
Eric and Cass
Eric Leinwand, Principal – Eric@wrightcovecapital.com
Cass Tokarski, Principal – Cass@wrightcovecapital.com