Our Thoughts on Second Quarter 2022

Matt Johnson, CFA® - Andy Nugent, CFA®


Market Recap, Portfolio Analysis, and Review

Second Quarter, 2022 showed us a glimpse into the effect of inflation, which is at a 40 year high and the Fed’s monetary policy. June’s inflation number rose to 9.1% and during the quarter, the Fed instituted two rate hikes in an attempt to control it. The result is that the consumer has less money in their pocket, and it is much more expensive to borrow money. If the goal is to slow demand by making everyone poorer, it looks like they are on the right track. We are left with a quarter that saw the S&P 500 decline significantly. This affects most people’s savings and/or retirement accounts. It is a scary thing, but we know this too shall pass. We have had many a downturn in the market through our lives, but the market is resilient and long-term it is better to stay in the game rather than time the market. The one good thing that happens when the market decreases is that we can uncover more investment opportunities for possible inclusion in the portfolio.


Inflation

During 2021, we believed inflation to be transitory. With so much shut down during the first round of Covid, and the backlog of container ships out at sea, we felt the supply shortage would remedy itself once they got the ships unloaded. Then, it was a trucker shortage. We were told the truckers got other jobs during covid and nothing was moving, but that in six months the shortage would subside as more truckers returned and new drivers finished training. Now we look back at the first half of 2022 and see food and oil shortages and prices continuing to climb. The June Consumer Price Index (a measure of inflation) rose to a 40 year high of over 9.1%, while the Personal Consumption Expenditures (all items less food and energy) ended about 6.3%. Inflation did not turn out to be transitory and it looks like a recession may be looming if the GDP numbers are negative at the end of July.


Recession? Our portfolio management philosophy does not change during economic cycles, we are long-term investment managers and will use any pull back in the market to uncover opportunities.


Interest Rates


Interest rates increased significantly from the first quarter. The 10-year treasury note yield increased to nearly 3% from 2.32% at the end of the first quarter 2022. Much of this is due to the Fed implementing two rate hikes. The first was a 50-basis point (0.50%) increase in May, followed by a 75-basis point (0.75%) rate hike in June.


As these interest rates rise, mortgage rates also increase. Per Bankrate, the average 30-year fixed rate mortgage rose from about 4.73% at the end of March to over 5.85% near the end of June. As a result, the number of mortgage applications are falling, which may result in real estate prices leveling off or possibly decreasing if the demand continues to sag.


Higher interest rates will likely have a negative impact to all asset classes, but particularly to bonds. At some point, the rates will be high enough to warrant fixed income purchases, but with even higher rates expected, we will hold off for now. However, if investing in bonds becomes necessary, we would focus on short-term bonds with the hope of rolling that money into higher yielding bonds as they mature.


Sector Analysis


The S&P 500 was down more than 16 percent in the second quarter, resulting in a decline of over 20% so far in 2022. While every sector had negative returns during the quarter, some fared better than others. Consumer Staples and Healthcare held up well, while Information Technology, Consumer Discretionary, and Communication Services underperformed the market. As you can see from the Sector Index chart above, many more sectors are trading near the bottom of their 52-week price range. This is allowing us to uncover possible additions to the portfolios as valuations become more reasonable. We are consciously being slow to add money to the market and maintain higher cash balances until we feel the market get a foothold. This very much benefited our performance in the quarter.

Industrials – Overall, this sector performed slightly better than the market. As mentioned last quarter, performance really depended on the industry within the sector. Aerospace and Defense performed relatively well. While other industries pulled back more. We invested in Stanley Black and Decker. The price is significantly down from the 52-week high, but they suffer from supply chain issues. We are taking a long-term view on this company and believe we will move beyond this. With a strengthening US dollar, we thought this was a fair time to take a small starter position.


Information Technology –The second quarter was not kind to tech as a rotation into what is perceived to be less risky sectors occurred. Many tech names traditionally sell at high multiples. As many of the large tech names begin to mature and growth rate slows, multiples should be expected to contract. This makes sense for a number of companies; however some may be being unjustly punished, which is pretty exciting for us. We are seeing a few names that traditionally are too expensive for us to purchase, fall into a more desirable range. One of our more recent purchases, Qualcomm, has pulled back in in price over 30% while earnings are expected to grow 25% next year. It is now trading at just over 10 times next years expected earnings. That is exciting for us investment nerds.


Consumer Staples – Consumer staples continue to be an area we like and maintain a significant weighting in. Consumer Staples are needed goods. People depend on many of these companies for food and drink. While these companies are experiencing increased costs to produce their product, they pass those costs on to the consumer. These companies have stable demand and fare better than many other companies when consumers are struggling and have less money in their pocket. In addition, these companies often trade at attractive valuations and pay higher than market dividend yields. They are not the most exciting names, but are companies whose products are used every day. Consumer staples is our second largest sector weighting and although we did not add to any positions in the quarter, we are happy with our holdings.


Healthcare – Healthcare is an area we continue to like at the right price. The sector held up well in the quarter. While we look for opportunities to increase our position, we are price sensitive, and price drives our investment decisions. That said, we lightened our position in the quarter paring back Bristol-Myers as the price approached our intrinsic value. We keep our eyes open to opportunities as many companies in the sector offer exceptional dividend yields and have solid financials.


Summary

As the second quarter ends, we see a lot of strong headwinds. As we repeatedly say, earnings are what matters. We look towards this next quarter of earnings season to see how these companies do. Do they have pricing power to continue to drive earnings, or will we see companies have a poor quarter? Keep in mind, it is OK for a company to have a poor quarter, and if that occurs, we will analyze why. Is it a short-term phenomenon? If so, maybe we have a buying opportunity. If something does change the inherent value of a business, we will stay away for now. Let us not forget, we are in this for the long-term. We will ride through the bumps and make additional purchases of companies that are unjustly punished by the market. Short-term volatility can be scary, but we do not let emotions control our decisions. Valuing companies individually, sticking to a process, and being disciplined, remain critical to long-term investing success.


We thank you for your continued confidence allowing us to help reach your financial goals.


Matt Johnson, CFA® Andy Nugent, CFA®




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.


SCA Qtr Commentary Q2 2022
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