The first quarter continued the volatility of 2022 in both the stock and bond markets. U.S. Treasury yields spiked to over 5% on both the 1 and 2 year for the first time since 2007. Stocks gave back gains from January in February and early March only to rally to close the quarter.
Amongst all this volatility, the Dow Jones Industrial Average, S&P Mid-Cap 400 and Russell 2000 are little changed (up or down 1% YTD) into the first few days of April 2023. The volatility is continuing with U.S. Treasury yields currently materially lower from those attractive 5% short-term yields. Stocks are likely to continue their significant divergence between the winners and losers. Similar to our thoughts going into 2022, we still see strong headwinds, including geopolitical uncertainty, which should cap any significant gains in stocks from current valuations.
During critical times, it is always beneficial to look back to see who was aware of the risks and opportunities well ahead of the crowd. A few years back, the Fed was unaware of the dangers of spiraling inflation as it stayed with its transient theme, which only fueled the inflation flames we experience today. These delays in the Fed’s response only makes inflation now more difficult to control.
This is what we had to say about inflation two years ago, during a time inflation was not on many investor’s radar:
“Many investors have yet to recognize the seeds of inflation that are already upon us. Official government inflation numbers do not include food or energy. In addition, government economists consider homes an asset—not a good or service to be consumed—so home prices are not factored into inflation data. Therefore, three of the key areas that are already soaring in price, that directly affect all Americans, are not even considered in the official inflation numbers.
The truth is that grocery prices are at seven-year highs, with the CRB Foodstuff index up 15% this year alone, while the prices of existing homes surged 17% last month, compared to a year ago, the fastest pace ever recorded. Investors not factoring rising inflation into their investment equations are making what will be a very costly mistake.”
Both the stock and bond markets suffered significant losses last year, which caught many investors by surprise. LanczGlobal warned those 60:40 allocated investors were taking as much, if not more, risk in bonds as in stocks. At the time, stock investors were speculating on SPACs, IPOs, and other hyped vehicles while believing that long-term bonds yielding 1-2% were safe (see Silicon Valley Bank). Here are our thoughts on the rise in stocks, again from two years ago:
”Investors have had a perfect storm of positives to fuel stocks higher, and that is something that will be hard to sustain. It started with the vaccine news in early November; add in TINA (there is no alternative to stocks) with interest rates near historic lows, combined with a hot IPO and SPAC market, and it is no wonder that stocks continue to hit new all-time highs throughout most of the first quarter of 2021.
The latest $1.9 trillion stimulus package only adds fuel to the pent-up-demand picture (after a year of lockdowns) that was going to be the next catalyst for even higher valuations. It is starting to feel like 1999 when an ever-increasing number of people became involved in stocks, not so much with a long-term strategy or analysis, but rather solely investing based on how much money was made in the latest SPAC, IPO, or meme stock. We have seen these episodes of the “greater fool theory” many times before. The bidding-up of certain investments to higher and higher levels can work, as long as there is someone out there willing to pay an even higher price. The key is understanding the risk one is taking and, most important, never being the last one holding the bag.”