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Special Client Letter - May 2022

May 06, 2022
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Dear Valued Clients:

Investment markets have continued to face a rough ride in 2022.  In the first couple of months, equity markets dropped into correction territory. That is a decline of over 10% from previous highs. In March, markets trimmed losses on hopes the worst was behind us.  The recovery was short-lived as markets again declined in the face of the triple threat of inflation, rising interest rates and the war in Ukraine. As we closed out April, many equity indices have returned to previous year-to-date lows.

Perspective on market declines

Frequent and meaningful communication with our clients is part of our process, particularly during difficult markets. The three previous calendar years were great for equity investors. Over that period, the S&P 500 roughly doubled in value.  While rewarding, the returns were not easy. We had to navigate the pandemic as well as other concerns with discipline and restraint. It is difficult to watch these gains, even partially, erode. But periodic market declines are part of investing. Since 1928, a 10% decline has occurred, on average, about every 19 months.

This time, we are hearing that the decline feels different from some of the others we have been through. We agree. The pandemic-related decline of the spring of 2020 was quick and event-driven. The bulk of the brutal 34% decline lasted less than a month. This decline feels different because it has been slower and grinding. The NASDAQ Composite, home to many big tech stocks, peaked in November of 2021 and has fallen into bear market territory (a decline of 20% or more).1 The S&P 500 peaked in early January of 2022.2 Since then, the optimism over vaccines and recovery has been replaced by a litany of systemic and event-driven concerns; supply chain disruptions, inflation, rising interest rates and the invasion of Ukraine.

Another difference between this and the previous decline is the relative absence of safe havens. During the pandemic sell-off, as risk assets like stocks dropped, lower risk assets, like bonds, particularly Treasuries, held firm and even rose, providing stability to portfolios. During market history, it is common for bonds to show strength in years where the equity markets decline. Not this time. The Fed has made it very clear that they will be vigilant in efforts to tamp down inflation. That likely means more and faster interest rate increases. Broad bond indices have fallen along with stocks. When we turn to the fixed-income portion of our portfolio this time, we see declines as well. There is, however, a potential bright side to the bond declines. As bond prices decrease, the prospect for higher streams of income in the years to come increases.

How to get through them

We know all the historical facts and figures about the regularity of market declines, while true, are not all that comforting when looking at your investment statements.  While declines occur for lots of reasons and have different durations and in varying magnitudes, it is the long-term effect on investors that matters. These effects fall into two groups. The first kind of decline is associated with the normal course of market movements. We are not dismissive of them. They can be painful and frustrating but unavoidable if one hopes to grow their purchasing power over time.

The second, and most dangerous type of portfolio decline, is “the permanent loss of capital.” This type of decline should be avoided if at all possible. While you won’t likely hear this phrase on CNBC or social media stock boards, it is over 100 years old. It is often attributed to noted U.K. 19th century economist and former endowment portfolio manager of King’s College, Cambridge, John Maynard Keynes. Dedicated followers include Benjamin Graham and Charlie Munger. It has long been a core concept of our firm as well. Mr. Buffet even alluded to this principle at the Berkshire annual meeting this past weekend when he lamented that many had turned away from sound principles and turned to a “casino-like” mentality. During the lockdown speculation craze, the battle cry was often, YOLO; “you only live once.”  Taking outsized, often highly risky, leveraged bets was a popular choice for some. This approach has probably resulted in a permanent loss of capital for many.  Similarly, trendy growth IPOs with no present earnings and SPACs have experienced large losses. We agree that we “only live once,” but that just strengthens our resolve to be good stewards of wealth.

We all know attempting to predict short-term market movement is difficult, and there are no guarantees. There are, however, things that we can do. We accept that investment markets are both risky and unpredictable. Portfolios should be mathematically built with that in mind. We try to avoid speculation and leverage. In our opinion, the end goal is not to outperform an index or your brother-in-law’s meme stock trades. The goal, as in the pandemic decline and today, is to weather the inevitable downturns and live to fight another day. That is what matters.

We use diversification, risk tolerance, Monte Carlo and efficient frontier analysis and other mathematical tools to help. While you may not care to hear an hour-long explanation of these tools, many clients are glad to know they are there. Remember that we are here; during the good times and the not-so-great times.  Let us know if you would like to talk things over.

 

CRN-4721635-050222

 1The NASDAQ Composite is an unmanaged index of securities traded on the NASDAQ system.

 2The S&P 500 consists of 500 stocks chosen for market size, liquidity, and industry group representation.  It is a market value weighted index with each stock's weight in the index proportionate to its market value.

 Sources: S&P Global, Dow Jones Indices, Forbes, CNBC, Morningstar, NASDAQ, Barclays, Reddit, Lincoln Financial Advisors. Diversification may help reduce, but cannot eliminate, risk of investment losses.  Historical performance relative to risk and return points to, but does not guarantee, the same relationship for future performance.  There is no assurance that by assuming more risk, you are guaranteed to achieve better results.  Past performance is not indicative of future results.