Wright Cove Capital: September 2022
September 22, 2022
Looking at some key financial indicators over Summer 2022, it appears to have been a fairly uneventful period for the markets. The S&P 500 began the summer at 3,764, and ended at 3,789 (up 0.6%), the 10yr treasury sold off slightly, but only from a rate of 3.31% to 3.53% – leaving most balanced or blended portfolios relatively unchanged.
Taking a deeper dive into the numbers, this summer was anything but uneventful. Gas prices came full circle beginning the summer at record highs before dropping back below $3.60 nationally, the US Dollar continued to rally and now stands at a 20yr high vs a basket of foreign currencies, but the real action – the exciting stuff – happened in the front end of the bond market. Rates on 3mth Treasury Bills nearly doubled (from 1.7% to 3.35%), yields on the 2yr Note rose above 4% for the first time since 2007, and as a result, conventional 30yr mortgage rates breached 6% for the first time since the summer of 2008.
As we near the final quarter of the year, we can say with confidence that we have officially entered a new investment environment. Fed Chairman Jerome Powell has made it clear (with both his words and actions) that the days of ultra-low interest rates are behind us, and we fear that many are unprepared for what comes next.
DON’T FIGHT THE FED
The broad-based stock market was up over 400% since the Fed moved their target to a range of 0.00-0.25% and began their ZIRP (Zero Interest Rate Policy) in late 2008. In the past fourteen years many have been championed as star stock pickers or legendary equity investors – and while there are without question brilliant investors who managed to beat the market – most of us have simply (and correctly) been riding the wave of liquidity gifted to us by the Federal Reserve.
DON’T FIGHT THE FED
For those who have been long risk assets (stocks, bonds, real estate or even business owners) since the Fed’s ZIRP was enacted, it has been a great ride. When Covid hit and $5 Trillion of stimulus was thrown upon us, it was like gasoline on a fire and the riskier the asset the more it seemed to appreciate. With all the euphoria also came record inflation – which like a global pandemic needs to be fought off before it spreads out of control.
DON’T FIGHT THE FED
So here we sit, with the stock market right back where we began the summer – but there are 2 major differences:
- For the first time in 15yrs – there are other very attractive and safe alternatives to stocks.
- The market is finally waking up to the fact that the Fed will do whatever it takes to tame inflation.
Where we go from here depends on numerous factors: The War in Ukraine, Inflation Data, Commodity Prices, Supply Chain Issues, Mortgage and Housing Data, Mid-Term Elections, and while President Biden declared “the pandemic over” we are still monitoring events on that front.
Ultimately, nobody knows where markets will be in six months or a year from now, but what we do believe to be true is the following:
- For those with short-term needs, or have a lower risk profile, 1yr treasuries now yield above 4%. We began buying 3mth and 6mth bills earlier this year and as they mature, we can roll them into higher yielding bills – still our favorite trade in fixed income.
- For those with a moderate or balanced risk profile, a well-diversified mix of high-quality stocks, short-term bonds, income generating covered calls, and/or exposure to alternate investments and commodities, now offers significantly more yield and income than in years past. We remain underweight equities, but as Fed tightening continues, we will look to increase our exposure into year end.
- And for those with a longer time horizon or higher risk profile, short-term declines in equities should be expected, especially after such an historic run. As the saying goes, “volatility is the price you pay for excess returns.” We have been raising cash levels and selling unprofitable and highly valued tech holdings all year in anticipation of higher interest rates and will soon look to add to sectors and securities that we believe can thrive in a more restrictive environment.
Many people in the financial world are familiar with the refrain “Don’t Fight the Fed,” and it is becoming a more commonly repeated mantra in everyday life. CNBC or Bloomberg is as common now in a dentist office as it is at a sports bar – and we hope that you can decipher what is actual financial news vs. what is entertainment, as those lines are being blurred more every day. Ironically, many of the talking heads, columnists and financial advisors who voiced their recent concerns over the Fed’s quest to crush inflation were the same ones who were confident that January’s sell off was a buying opportunity, or they were quick to produce a graph or chart at the onset of the Ukraine War that showed how markets are usually higher after “similar conflicts” in just months.
For the past 20+ years we have seen firsthand that Federal Reserve policy and the path of future interest rates is the biggest determinant in financial markets. There have been sub-plots, crises, and triumphs along the way – but at the end of the day, we at Wright Cove Capital stand by the notion that Feb Policy is and will continue to be the biggest contributing factor when making any investment decision.
With the wind no longer at our backs, as Fed policy has shifted dramatically from accommodative to restrictive, we cannot think of another team that has the insights, experience, and risk management skills needed to succeed in this current interest rate environment and are here to help our clients navigate volatile markets.
As always, if you have any questions or concerns – or would like to hear more about Wright Cove Capital, please fee to reach out.