Our Thoughts on First Quarter 2022
Matt Johnson, CFA® - Andy Nugent, CFA®
Market Recap, Portfolio Analysis, and Review
The 1st quarter of 2022 began with the US seemingly moving past Covid. Mask mandates are being lifted and it seems like things are finally getting back to normal. The big concern is the increasing inflation rate and what the fed is going to do to try to slow it. They mentioned they will start tapering the number of bonds they purchase. They raised interest rates in March by 25 basis points in an effort to slow the economy. This all seems reasonable. Supply chain issues look to be improving. With the war breaking out in Ukraine, this is putting pressure on commodity prices and adding to inflation concerns. The U.S. implementing sanctions resulted in a significant increase in the price of oil and caused concern about what will happen next. Previously, we noted our amazement that the stock market was able to look past events that should have driven it lower. The first quarter showed that an accumulation of these events was too much for the market to ignore. We witnessed the S&P 500’s volatility increase, and the stock market pull back almost 5%.
Inflation was a big topic of conversation in the fourth quarter and remained that way into the beginning of 2022. The President signed an Executive Order banning the import of Russian oil. Coupling that with the US political stance on drilling resulted in the price of oil increasing over 30% over the quarter. Commodities prices also surged. Wheat and corn were up well over 25% as the war is causing a shortage in Europe, so prices here rise as well. This in turn causes cereal companies like General Mills and Kellogg’s to have a higher input cost in producing their products, and they in turn pass those increases on to the end consumer through higher prices.
It appears prices are higher everywhere we look. From food to gasoline, we have seen a large increase in prices. The March inflation rate as measured by the Consumer Price Index was over 8%. Although the headline number is slightly higher than consensus expectations, a meaningful part of that was due to the increase in energy prices. In fact, the price of used vehicles declined almost 4%. Overall, we do not think inflation will continue at this rate and believe the March number (which was released in April) could be the peak, but we will have to wait and see if that is truly the case.
There are signs that supply chain issues are easing. Looking at the Long Beach / LA ports, the number of cargo ships waiting to off load has dropped from over 100 on January 1 to just over 40 in the middle of March. The Port does warn we could see another spike once the Covid lockdowns in China are lifted.
Interest rates increased significantly in the first quarter. The 10-year treasury note moved up to 2.32% from 1.51% at the end of 2021. This was largely due to the Fed increasing the Fed funds rate by 25 basis points and the assumption that more increases will follow. While we believe the Fed will implement additional increases throughout the year, we think they will do so cautiously and will raise rates no more than necessary.
As interest rates rise, mortgage rates will also increase. Real Estate prices currently remain high due to the low inventory of homes on the market, however, as mortgage rates increase, the amount an individual can borrow will decrease given the same monthly payment. We feel this could have a negative impact on housing prices, especially if inventory increases.
Higher interest rates will likely have a negative impact on all asset classes, but particularly to bonds. We remain cautious of fixed income investments. Prices of existing bonds fall when interest rates move higher. If investing in bonds is necessary, we would focus on very short-term bonds with the hope of rolling that money into higher yielding bonds as they mature.
Although the market is down less than 5% so far this year, it has felt more painful. Maybe it is because we have experienced such an extended run in the equity markets, March of 2020 excluded, of course. Over the last year, every sector is higher except Communication Services. When looking at prices versus the 52-week high (chart above), we can see that most are closer to the highs than the lows. The market is not cheap, but we have been able to add to a few names that pulled back in price and sold out of others that reached our sell price.
Industrials – Performance in this sector has really depended on what industry they are in. Some have pulled back, allowing us to add to our position, others have marched forward. Aerospace and Defense companies have had strength through the first quarter. We have a few companies in this area. Lockheed Martin and General Dynamics both had good returns. Lockheed Martin reached its sell target, and we exited the position. In addition, General Dynamics reached a point to where we pared back the position raising a bit of cash in the portfolio. We added to our position in Federal Express whose price continued to fall, but we remain confident in their long-term prospects.
Information Technology – This sector is very interesting because it largely consists of two types of companies. One type is the very profitable industry leader who has strong revenue growth, strong earnings and a strong balance sheet that is able to withstand temporary economic volatility. The other type is a company that shows promise, may be growing revenue, but is making very little to no profit. This type of company is trading at very high multiples in the hopes that they will be successful in the future. We think the latter will not do well in a slowing economy with rising interest rates. Last quarter we saw these companies pull back significantly while the strong mega-cap companies held up much better. As such, our portfolio favors the strong side of tech. So far, earnings and revenues have continued to grow, and we will look through short term volatility, and have cash flows and earnings to assist in defining our valuations.
Consumer Staples – Consumer staples continue to be an area we like and maintain a significant weighting in. Most of the names we hold have strong pricing power, meaning they pass along any cost increases to the end consumer. Companies like Tyson, Kellogg, and Smucker will likely raise prices, but consumers still purchase their products. These types of companies typically perform relatively well in a higher inflationary environment. In addition, this sector tends to trade at lower multiples of Price to Earnings, Price to Cash Flow, and offer higher dividend yields than many other sectors. We continue to feel our holdings here will move higher and will withstand market volatility over the longer term. We held steady and did not make any changes to our portfolio over the quarter in this sector.
Healthcare – Healthcare is an area we continue to like at the right price, but appreciation of the stocks is causing us to lower our overall exposure as companies hit our estimates of their value. After selling out of CVS Health Corp in the 4th quarter of 2021, we continued to trim our exposure in the first quarter of 2022. We exited our position in Cardinal Health as its price exceeded our estimation of its true worth. In addition, we pared back our position in AbbVie as its price is up and we wanted to take some profits off the table. We still believe AbbVie has upside and are holding on to a smaller portion of the company. We would love to increase our allocation in this sector, but only at the right price. If we do see a market pull back, we hope it affords us the ability to invest in these well capitalized, high dividend stocks. It is important to note, that as much as we like the sector, price drives the day. We value each company individually.
The first quarter of 2022 seemed to start out with a return to normalcy as we begin to put Covid in the rearview mirror. Then a war breaks out! Honestly, it really does seem that the economy is always worried about something. We have seen historical events in the past couple of years and it seems we have a new one with the war. Rates are moving too high or too low or too quickly. We hear “Oil prices are going to $150 a barrel”, or just two years ago the futures valued oil at a negative price. As investors, we need to keep apprised of these things as they do move the market in the short term. However, let’s not forget, we are in this for the long term and individual company earnings rule the day. Short-term volatility can be scary, but Long-term investing is not. Valuing companies individually, sticking to a process, and being disciplined, remain critical to our long-term investing success.
We thank you for your continued confidence allowing us to help reach your financial goals.
If you would like to receive quarterly recaps, contact:
Andy Nugent, Director of Investments
Sage Capital Advisors, LLC is a Securities and Exchange Registered Investment Advisor. Sage Capital Advisors is headquartered in Sioux Falls, South Dakota. Advisory services are only offered to clients or prospective clients where representatives of Sage Capital Advisors are properly licensed or exempt from licensure. This market commentary is solely for informational purposes and should not be construed as investment advice, it is only intended to provide education about the financial industry. Historical performance results for investment indices and/or categories have been provided for general comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of investment management fees, or the impact of taxes, all of which would have the effect of decreasing historical performance results. Indices are unmanaged and cannot be invested in directly. It should not be assumed that your account holdings correspond directly to any comparative indices. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered unless a client service agreement is in place.