Analyzing Market Turmoil | Podcast

Analyzing Market Turmoil

May 18, 2022

Episode Description

FEATURING Charles Toole, Steve Johnson, and Jeff DeMaso

Both stock and bond markets have been in a tumultuous drawdown for most of 2022. Is there any light at the end of the tunnel? Or do inflation, high interest rates and a slowing economy mean more pain is in store for investors? Charlie, Steve and Jeff lead you through the trends they’re seeing in today’s markets, including:

  • Whether we’re in for more bear market turmoil
  • The resurgence of fundamentals
  • Why inflation has proven so sticky

There’s been more downs than ups so far in 2022. But staying the course is still the savvy move. Listen now to find out why!

Episode Transcript

Jeff DeMaso:

While investing in the stock market has been rewarding over time, it certainly doesn’t feel that way right now. And with bonds down this year, even conservative investors are under pressure. Join us as we try to make heads and tails of the current market environment.

Charlie Toole:

Hello, I’m Charlie Toole, a portfolio manager at Adviser Investments. And welcome to another The Adviser You Can Talk To Podcast. It’s been a volatile start to the year for the stock market, with the S&P down around 15%. But it’s been a volatile start to the year for the bond market as well, with bond prices down nearly 10%. And that has just about every investor upset or feeling ill. So today, we’re going to talk about some current market situations, hit on both the corrections in stocks and bonds, but get into some of the other parts of the market and talk about the Fed and inflation. Sort of a mixed bag, if you will, of market topics. Joining me today is Jeff DeMaso, director of research. He is responsible for overseeing the investment team, and he also is the portfolio manager for our core mutual fund portfolios. Jeff, thanks for joining me today.

Jeff DeMaso:

Hey, Charlie, thanks for having me back.

Charlie Toole:

Also joining me today is Steve Johnson. He’s a vice president and portfolio manager. Steve and I co-manage the dividend and income portfolio. Steve’s a Certified Financial Planner that also works with clients. Steve, thanks for joining me and welcome to the podcast.

Steve Johnson:

Yeah. Real happy to be here again.

Charlie Toole:

All right. So let’s jump right in. I talked about both corrections in the stock and bond market and how this is really hurting investors. I actually went back and looked. Over the last six months, if you’ve been a conservative investor of 30% stocks, 70% high-quality bonds, you’re down about 11.5%. You go back to the financial crisis in 2008 and your worst returns were anywhere from 13% to 17%. And really that 17% was a one-day outlier. So on average, we’ll just say at the depths of the great financial crisis, conservative investors were down 13.5%. So we’re getting really close for conservative investors today. And Steve, I think, as I mentioned, you work with clients. What are you hearing from some of your conservative clients regarding this overall market?

Steve Johnson:

Charlie, you hit the nail on the head. I think the most difficult conversations that I’m having are with those portfolios and those clients that are conservatively positioned. Because we have them there for income, for lower volatility, lower drawdowns. And yes, there have been lower drawdowns than an all-stock portfolio. But those declines in the bond market we’re just not used to seeing. And it’s hard for clients to understand that yes, bonds are self-healing. They will come back to par. Bond funds have the ability to reinvest at higher rates now, but it’s going to take some time. And that’s something that they’re dealing with and it’s a difficult conversation. But understanding that it is appropriate for them at this level and we know that the equity market will come back as well as the bond market.

Steve Johnson:

But I guess we’re all struggling with that, though, Charlie, for the conservative investor. And I think they’re also nervous about what’s ahead. Because I think there’s so much talk about inflation, so much talk about oil prices being where they are, as well as food prices, that there’s a fear, I think, that rates are going to escape from here and that folks are going to continue to lose money in the bond market. I think being able to address that for clients is very important. Understanding that we are in different times, this is an anomaly here, where bonds and stocks are going down at the same time. And eventually, things will return back to normal.

Jeff DeMaso:

Yeah. If I could jump in. Charlie, those stats were pretty dramatic at the beginning—just how difficult it’s been for the conservative investor. And as you said, the S&P’s only down 15% or so. So we haven’t even really hit bear market territory at the overall stock market level. And yeah, not to be blasé, but it echoes Steve’s point. This too shall pass. With time, bonds will heal. With time, the equity market will recover. We know that bear markets happen, but bull markets tend to outrun bear markets. But it’s not to diminish the difficult environment that we’ve been in. And a little bit of a silver lining is that bonds have started to behave a bit better. We’ve seen yields kind of stabilize around the 3% on the 10-year level. So bonds are starting to provide that balance in the portfolio that we all would’ve expected out of them earlier in the year.

Charlie Toole:

That’s a great point, Jeff. And then something that I think bears repeating is that over the last week or two, we’ve seen more normal behavior from the bond market relative to the stock market. Stocks have continued to be volatile and continued to drop, but bonds have started to perform better, which is what we would expect. So hopefully that sort of calms the nerves a little bit for conservative investors. As I said, it’s been a tough six months. But again, we’re there, it’s already happened. It’s what happens as we go forward. Jeff, I want to pull on a thread that you mentioned, where it really hasn’t been that bad for a stock investor when you look at the aggregate market down only about 15%. I think if you sort of peel the layer of the onion back and look in certain places, there has been some pain in the equity markets as well.

Charlie Toole:

Just looking at some year-to-date numbers, these aren’t even off of all-time highs for some of these stocks. But General Motors is down 36%, Starbucks down 37%, Boeing down 37%, Disney down 31%. These are some blue-chip companies that have really taken a hit. And if you go even further, to some of the successful stocks from COVID, work from home, entertainment from home, Facebook is down 40%, Amazon down 33%, PayPal down 58% and Netflix down 70%. So depending where you’ve been invested, there’s some pain that’s been felt in the equity market as well.

Jeff DeMaso:

Oh, 100%. And as you said, those are just some year-to-date numbers. If you take them from prior highs, they’re even more dramatic. Just to give you one of those work-from-home darlings, Peloton peaked in its share price in July 2021. It’s down 89%. I mean, talk about pain. So yes, at the overall market level, down 15% or so doesn’t look so bad. But if you’ve been leaning toward—if you want to call them growth stocks, if you want to call them work-from-home stocks—the pain has definitely been more acute. And the poster child for that is probably Cathie Wood’s ARK Innovation ETF, which from its high is down 73%. For those investors that maybe piled in after her great return, it’s got to be a disappointment. So maybe we can talk about her at some point here. But I guess the question then is for investors, as we’ve said: What happens from here? Is there opportunity in some of these great names?

Jeff DeMaso:

As you said, Amazon down roughly 30% on the year, down 40% from its high. Netflix down even more. Are these companies going out of business? Are we going to stop using Amazon? Are we going to stop using Netflix? And maybe we’ll consume a little bit less Netflix now as we all go back outside and demand more services. But I guess we’re trying to see—is there opportunity here? And trying to call the bottom is incredibly difficult. A stock can always go from cheap to cheaper to even more cheap from there. But you’ve got to think that there’s opportunities being created here as well.

Steve Johnson:

Jeff, what we’ve seen—and we’ve talked about this now kind of for two years—is that it was crazy. Let’s just call it what it was. It was stupid crazy, right? People buying stuff who didn’t know anything about what the company was doing. And we sat here kind of just not believing what was going on. What has happened is everything reverts. And so that level of speculation is now being removed, and it’s being removed because the Fed is removing some of that liquidity. And rates are moving higher. The money supply is lower. And people are getting a lesson on speculation. As we’ve seen, even over the last couple of weeks, that has spread over to the crypto market, right? That does have at some point a negative wealth effect, too, where all these folks who made all this money in the last couple years found out they had to pay taxes and now they don’t have the money, perhaps. So that’s having an impact. And it’s just really—to your point exactly, though—the pendulum is now swinging back.

Steve Johnson:

And I think the job for investors and managers is you’ve got to go through the wreckage here and now figure out which ones are going to be the survivors. And to your point, in the growth market, where the average NASDAQ stock this year is down from its high about 40%. The question is where does quality emerge, right? Where does quality emerge? People who have gone the opposite way now, people who have gone real defensive or who have invested now in perhaps what people consider to be value—at what point does that change? And at what point is there so much money that’s gone into value that people realize that, well, there are these other companies over here that are outstanding quality growth names that are trading now at valuations that are reasonable again.

Steve Johnson:

I think that’s one thing we can probably talk about—the valuations. I know people say, “Well, in bear markets, you hit a trough of roughly 14 or 15 times earnings. And we’re at 16 and a half right now. So gosh, we’ve got to go down so we get to that level.” Well, there’s no rule that says we have to, first of all. And I think that’s the big challenge for all of us here: At what point do those earnings reflect the valuations that we’re seeing now?

Charlie Toole:

Yeah, Steve, I think that’s a great point, where you talk about the high-quality companies or the companies that are generating cash. A lot of what both you and Jeff are talking about is eerily similar to 2000 through 2002 and the late ’90s and the dot-com bubble, whether it’s stocks that did really well losing 70%, 80% of their value or retail investors who were day trading stocks and doing well, whether it was in these work-from-home stocks or cryptocurrencies. The same thing was happening with internet stocks, and coming out of that, it was the high-quality companies, the cash-flow-generating companies that did very well. I think that’s probably likely to be the same thing here. The winners coming out of this are the companies that have a strong position and are generating a lot of cash.

Jeff DeMaso:

I agree, Charlie. And there definitely are some parallels to 2000 and 2002 and kind of the tech bubble unwinding. And I think one of the big lessons there was: The price you pay matters. If you bought even a great company that survived, Microsoft, at the peak of the market at just an outrageous multiple in 2000 and you held on, it took time for it to recover, and it did. The logical question is where are we right now? If we’re in a period like 2000, 2002, and we’re unwinding, are we early in that stage? Are we closer to the bottom? And I think it’s incredibly difficult to time a bottom and probably call it. Expecting to be able to do that is unreasonable. What I would say is if you invested and stuck to your discipline through—whether it was that burst into the tech bubble or the global financial crisis—if you’re able to stick with your discipline, with time, the results did come in your favor.

Jeff DeMaso:

And if you’re able to put money to work during those drawdowns, maybe they didn’t feel great over the next three, six months. But if you were to look out three, four, five, heaven forbid even 10 years with a longer time horizon, those investments made at difficult times were well rewarded. And I think this is a moment where if you’re worried about your portfolio, if you’re that conservative investor who’s down 11% wondering what the heck’s going on, I think it behooves you to take a step back and think about your portfolio in context of your goals and what you’re trying to achieve.

Jeff DeMaso:

Hopefully, you’ve done a financial plan that can help you see if you’re still on course to achieve those. If not, now is probably a good time to do that. And if you’re still on course, that can be a nice check. OK, I don’t need to overreact to the short-term market environment. Maybe now is the time to rebalance my portfolio from what has held up relatively well toward what’s down and recognize that maybe you’ll have to do that again to keep your portfolio in check. But that adds a way to do this in a disciplined manner as we go through these difficult market environments.

Charlie Toole:

That’s an excellent point. I think fear and greed can really drive investor decisions sometimes that don’t work out the way that you want, whether it’s fear of missing out, or FOMO, or just fear with the market going down. If you’re reacting emotionally, that can be detrimental to your financial health.

Jeff DeMaso:

Yeah. In fact, and I could jump in—Steve mentioned the crypto market. I think that’s a great place where emotions, both fear and greed, are readily on display. As you said, people not always getting what they expect. There was a so-called stable coin. The idea is that it’s supposed to stay at a dollar. Think of it like a money market fund in the crypto space. And it broke the buck. So all of a sudden, investors weren’t getting what they expected. And there was another cryptocurrency that we saw that went from 190 or something like that down toward zero, essentially worthless. Lost pretty much all its value. The drawdown in bitcoin has been pretty dramatic of late. And the crypto space is one where emotions are on display.

Jeff DeMaso:

I think you can kind of explain the volatility because my theory is that what’s fascinating about bitcoin is it didn’t exist, whatever, 13 years ago. And we’re all trying to decide if this thing that didn’t exist before and is just some numbers on the screen, does it have value, right? If more people buy into the story of bitcoin and that it has value, it’s going to go up in price. And if we all agreed that it had value tomorrow, it should probably be worth a lot more. But at the same time, if people are skeptical of that story or questioning that story, well, then there’s nothing underpinning the value of bitcoin. That’s why you see these dramatic declines as that pendulum swings, as Steve was alluding to, between buying into the story and not buying into the story. And bitcoin’s an extreme example, but I think the same applies for some of these growth stocks or whether you’re kind of buying into the future potential that they represent or not.

Steve Johnson:

Jeff, to your point—you mentioned the key there and it is story. People were buying narratives, whether it be meme stocks or crypto—that this was an alternative currency, that things would be different. And unfortunately, the fundamentals matter for those people. That’s what we’re starting to see now. The positive of this, coming out the other side, is there are always going to be a new set of winners. But it allows managers to actively search for those winners and to do homework. And to be honest with you, homework hasn’t mattered for the last five years. It really hasn’t. It’s all been dictated by flows, and buyers lived higher and sellers lived lower. And what I mean by that is those names that were going up, well, they kept going up because people kept buying them.

Steve Johnson:

And then all of a sudden it reversed. And we know momentum works both ways. We’ve seen that across many different asset classes as well as different sectors. Now, the real challenge is: OK, we’ve had this drawdown. Perhaps it’s not a bear market in the S&P 500. But to your point, it allows me as an investor to reassess, take a look at my portfolio, perhaps rebalance, and then also take stock of where we are. And I think getting back down to fundamentals—that is going to help investors, so we can get away from the narrative but kind of focus on what’s important. Things that we always talk about. Earnings, interest rates, policy. Those things are going to be more of a factor going forward, hopefully, over the next couple years than what we’ve seen. And it’ll allow us to kind of really get back and really get clients to focus on what’s important.

Charlie Toole:

Good point, Steve. And I want to, because you mentioned earnings, interest rates and policies, change directions toward interest rates and Fed policy. Because we touched upon it a little, but I think inflation and the Fed’s rate-hike cycle has sort of been dominating the financial news. Last week, we did get an updated inflation report for April. And I think that report had something for everyone. Inflation was slowing year-on-year, but it was still elevated. And month-over-month inflation was increasing. Some of the individual components were also positive or negative depending on your view. Used car prices, I think, were down for the third consecutive month. But rent or owners’ equivalent rent, which is a big portion of CPI, was starting to increase. So Steve, you’ve been talking about those—what you call sticky inflation. Why don’t you sort of explain what sticky inflation is and what that was doing or is doing as of the last report.

Steve Johnson:

Yeah. So what we see, Charlie, is obviously a change from the pandemic, right? So people, we were going from things that we purchased now to more things on the service side. Things that are really impacting our lives, things like food, oil. All of those pieces—rents, as you mentioned—those have been stickier, I think, than many of us thought. And whether you blame the war in Ukraine or just the fact that perhaps the Fed was not as aggressive as they could have been last year with all the stimulus, that is becoming an issue. And what’s interesting is we saw oil break out yesterday, for example, at $113 a barrel. Gas prices—and I know obviously gas prices aren’t the same because cars are more efficient, we’re not driving as much and incomes are up. But still, it was $4.49 yesterday.

Steve Johnson:

You see on Twitter everyone taking pictures of their bill that day. And I’ve seen $100, $125. And it is having an impact. I actually had a conversation with a client today who was talking about food prices and how she and her son are sharing and cooking more, they’re splitting because food prices have gone up. And so that is going to have an impact. We saw it today with Walmart’s earnings. Walmart had decent sales, although a lot of those sales were due to the pricing being significantly higher. We even saw that with Home Depot. Transactions were lower, but the price of those transactions was higher, resulting in higher comps. But Walmart said, “Listen, our average consumer is being impacted by these higher costs.” And so that’s the pressure that the Fed is under. And I think clients have been asking, “Do you believe in a hard landing or a soft landing?” And I don’t know the answer to that. I don’t think any of us do. But what we do know is clearly, it’s having an impact. And the fact that interest rates have been going up on the mortgage side.

Steve Johnson:

I guess the real question is what is the strength of the consumer and our corporations? Will earnings be impacted? Now we saw today with Walmart that finally, yeah, it caught up to them in terms of their margins being impacted. Will that spread over to other companies? Perhaps. And that’s why I think many people are worried about earnings in the future. But again, to make a bold prediction that we are going to have a hard landing and we’re going to see recession—it’s too hard to make that call. And to be honest with you, just because that may be the case, it doesn’t mean the market doesn’t do well. I mean, I think one of the things that we saw in March of 2000—the economy was on its back in 2020. I mean, it really was beat up. But the equity market did very well.

Steve Johnson:

One of the things that I know, Jeff—you sent down article yesterday—is that perhaps what we see is that six months from now, all the inventories that we see…like Walmart has extremely high inventories. We’ve got all these container ships in China that will come on here in the next six months. China’s opening up again. What happens if we actually get oversupply in the next six months? And all of a sudden, we’re not talking about inflation. We’re talking about disinflation. Not outright deflation, but disinflation. The narrative again has changed and we don’t hear a lot about that. But I do think that is something that we could see in the next six months, which would make all of us feel better as it relates to oil prices, food prices and even bond yields.

Jeff DeMaso:

Steve, I think those are all great points. And there are a lot of different narratives in there. But if we bring it back to the portfolios, look, I completely agree. Hard landing, soft landing, has inflation peaked? Really hard to get those right. And even if you do get it right ahead of time, you then have to correct how the market’s going to respond. And those are difficult. That’s two different things that are hard to get right. So how do we translate that into managing a portfolio, whether it’s your guys’ equity portfolio, which is geared toward dividend growers, or the balance-diversified portfolios that I oversee for clients? And I think it all comes down to trying to build portfolios that are resilient.

Jeff DeMaso:

You want to have some stocks or some funds or some piece of the portfolio that can do well if inflation does stay high. But you probably want some other names that are going to do well if we get that disinflation experience. And so again, it comes back to building portfolios that can do well given a variety of outcomes, as opposed to just making one massive bet on one outcome. Because I know you need to get that outcome right but also the market side of it right. And again, easier said than done on both accounts.

Charlie Toole:

It is. And Jeff, elaborating a little bit more on your diversification of portfolios and something that’s resilient in all markets, the great analogy that I heard from a European strategist—he spoke about soccer, or as he called it, football. But he said, “Your team on the field is diversified. You don’t have all defenders or all strikers or all goalkeepers. You have a mix of everything so that your strikers can score, your defenders can defend and your goalie can obviously save shots.” And that’s what you want when you build a portfolio. You want some offense and some defense, things that will do well in different environments. And I think that, to your point, we try to do that across the board. Whether it’s you, myself, the other portfolio managers here—we’re trying to build resilient portfolios for all environments.

Charlie Toole:

All right. Jeff, Steve, thank you both for joining me today. This has been Charlie Toole, Jeff DeMaso and Steve Johnson for Adviser Investments, thanking you for listening to The Adviser You Can Talk To Podcast. If you’ve enjoyed this conversation, please subscribe and review our show. You can check us out at adviserinvestments.com/podcast. Your feedback is always welcome. So if you have any questions or topics you’d like us to explore, please email us at info@adviserinvestments.com. Before closing, I’d like to thank Kailey Steele and Ashlyn Melvin. They do all the hard work making this podcast possible. And thank you for listening today.

Podcast released on May 18, 2022. This podcast is for informational purposes only. It is not intended as financial, legal, tax or insurance advice even though these topics may be discussed. Past performance does not guarantee future results. All investments involve risk and can lose value. Always consult a financial, legal or tax professional before taking specific action. Information and events addressed in this podcast, as well as the job titles, job functions and employment of the podcast’s participants with respect to Adviser Investments, LLC may have changed since this podcast was released. For more information on each individual featured in this podcast, see the Our People section of our website.

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A little bit of a silver lining is that bonds have started to stabilize, and are now starting to provide that ballast in a portfolio that we were expecting earlier in the year.


Jeff DeMaso, CFA

Director of Research

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