Unprecedented Volatility

Markets are much changed since our last letter. There are many issues behind the moves. The main issues are inflation, the Russian invasion of the Ukraine, falling covid cases, the outlook for interest rates and the outlook for the world economy.

Covid cases are falling sharply in most of the world. Many countries are slowly dropping travel restrictions while simultaneously re-opening their economy to pre-covid levels. We expect this trend to continue and result in strong economic growth around the world. While inflation is a threat to this increased consumer spending, we believe recent geopolitical events will increase this trend. Consumers are showing a propensity to spend. They lived through the threat of covid. Now they are confronted with a dictator in Russia potentially destroying world peace. Both events are creating a reason for consumers to examine their “bucket list” with the goal of crossing off a few entries. This may be travel, buying a new vehicle or a new house, adding a pool or extension to their existing house, buying different clothes, attending sporting events etc. A recent survey of Europeans revealed many people saying they always wanted to visit the United States. They now pledge they are going to do the same. Good for the U.S. economy.

The Russian invasion of the Ukraine is tragic in the suffering and deaths it will cause before it is over. The economic results are not as certain. A world-wide recession that some predict is not a certainty. Higher prices for certain commodities are more of a guarantee. While difficult to deal with the prices, it is not a precursor to ruining the world economy. We hope that a negotiated end to the invasion can come soon.

Before the invasion, inflation was moving significantly higher. This was sure to bring about an increase in interest rates in the U.S. and elsewhere. There is nothing that changes our opinion about inflation. If anything, the war will cause inflation to be even higher than pre-war. Interest rates will need to go higher than previous expectations. Central Bankers including our Federal Reserve may go much slower in raising interest rates due to concerns about the Russia/Ukraine tragedy. This will only assure that inflation and interest rates are headed higher.

We expect bond prices to trade much lower between now and year end regardless of what happens overseas. Only keeping durations as short as possible will prevent fixed income losses. The stock market will trend lower over the year marked by intermediate periods of rallies, only to later make new lows. Buying the dips will not work. Commodity stocks are performing well and will be a small area of the stock market that will perform. Commodity prices from beans, corn, wheat, oil, natural gas, copper, gold etc. will be volatile, but are not going back down to levels of a few years ago. The Nasdaq YTD is down 17%, the S&P is down 11.4%. Energy stocks are, on average, up 35%. Global metals and mining are up 11%. Commodity related stocks are, on average, up 20%.

Our managed portfolios are showing slight gains YTD. Our positions for the last 18 months have avoided high flying Nasdaq issues with little investment merit, while concentrating on good cash flow generating companies with positive exposure to inflation.

We view a strong world economy. However, we believe the best investment approach is one of selection and caution.