Roger Banks, RRC
2022 Market Update
There has been no shortage of risks in 2022: levels of inflation globally not seen in decades, supply chain disruptions x2, a war between Ukraine and Russia and COVID-19 related shutdowns in China.
The U.S. economy contracted by 1.4%, on a seasonally adjusted and annualized basis, in the first quarter of 2022. The consensus expectation for Q1 GDP, according to Bloomberg, was for a 1% gain, much slower than Q4 2021 GDP of 6.9%. While the number was negative, there were some positive components to the final number—such as strong imports, services, and purchases of durable goods (goods that are able to be kept for a period of time), which indicate a healthy consumer. A slowdown in U.S. economic growth has been long expected but the surprising negative period has led to talk of a recession, broadly defined as two consecutive quarters of negative GDP growth and the potential of an equity bear market along with it.
While we were surprised at the negative announcement, we maintain our stance that a typical recession in 2022 remains a low probability event.
However, in the midst of chaos, there is also opportunity.
Regardless of any recession and their nuances, high-quality dividend payers and growers perform well prior to, during and after the recession. Where it is impossible to ‘time the recession’, an asset allocation that consists of a sleeve of high-quality dividend growers is important for risk-adjusted returns.
What are ‘high quality’ dividends?
Dividends that are supported by companies whose earnings remain resilient through different economic cycles (meaning, high percentage of ‘recurring’ revenue).
Dividends that are supported by a business that can invest in organic growth while expanding margins.
Dividends that are supported by a business that have pricing power and opportunities to grow market share.
Dividends paid by companies that have high and consistent ROE (return on equity)
Our Dividend Income Fund in your portfolio holds true to time-tested systems and processes of pricing stocks while implementing the definition of “High Quality” dividends as described above. This is one of the ways we are actively positioning your portfolio to navigate through the current environment.
The other rebalancing that is happening in your portfolio is in regards to Bonds. In times of interest rate movements, holding short-term duration placements is key, not “locking in” a yield for 5 years that may become devalued as interest rates increase. This keeps a Bond Portfolio current dated and flexible to reposition for the best opportunities as they develop. Our Strategic Income Team from Boston and the Yield Opportunity Team from Toronto and Calgary lead the industry in this strategy.
All our mandates are actively managed 24/7, daily and by the hour, tactically researching the best opportunities available.
We maintain our stance that a typical recession in 2022 remains a low-probability event. An economic slowdown is our base case, and it could lead to a pivot in the U.S. Federal Reserve’s hawkish narrative, which would be positive for both equities and fixed income. Despite the surprise, it’s not the time for a knee-jerk reaction when it comes to an investment portfolio.
I recently came across the analogy below from Manulife Capital Markets Team where they use the analogy of a Bear attack in comparison to the “bear markets” (referring to periods of market decline). These four simple rules are a very wise framework to use during these periods of heightened volatility. They are loosely based on advice in the event one comes face to face with a bear in the wild…yet the sentiment of the rule is very applicable to what we face today with Equity markets.
Rule #1 – Vanquish fear and panic. When it comes to the stock market, there’ll always be a reason to sell. Negative headlines stoke fear in the minds of investors and that’s a natural reaction from a human behavioral perspective. Loss aversion is a cognitive bias, which explains why individuals feel the pain of a loss twice as much as the equivalent pleasure of gain. As a result of this, individuals tend to try to avoid losses in whatever way possible.
Similar to a bear attack in the wild, corrections can happen at any time. Stock market corrections (a drop of 10% or more) are common and very difficult to predict. Since 1980, the S&P 500 Index has fallen an average of 14.3% in any given calendar year but is positive 78% of the time with an average return of 10.3! The key is to position an investment portfolio defensively prior to recessions that correspond to large equity drawdowns. (using High-quality Dividend payers and short-duration Bonds, preferrable high yield and Inv grade.)
Rule #2 – Know your environment. Our work would suggest that the U.S. economy has begun to slow down and will continue to do so throughout the year. But let’s be clear: despite the slowdown, the probability of a traditional U.S. recession over the next 12 months remains low. When we say traditional, we mean one that lasts 10 months, on average, and often coincides with elevated unemployment. A technical recession, where GDP is negative over two consecutive quarters, is possible, but we believe a sustained bear market is unlikely.
Rule #3 – Take advantage of opportunities. For the long-term investor, it’s important to remain focused on the fundamentals. Warren Buffet attributes some of his success to being a contrarian investor. He famously said, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.” Investors know this investment truism to be accurate but it’s often hard to execute.
The VIX Index is a great measure of the amount of fear in the markets. When the VIX index is high, there’s more fear amongst investors. Since 1990, the VIX has averaged approximately 19, and a measure above 30 is an important level that signifies extreme aversion to equities. The VIX is once again above 30. Historically, when the VIX has breached 30, the S&P 500 Price Index return has been positive more than 80% of the time one year later.
Rule #4 – Don’t be afraid of what goes bump in the night. If something is meant to harm you, it’ll stalk you silently. There’s another behavioral bias called confirmation bias. This is where investors seek out information to prove their beliefs. If they’re worried about the economy or markets, they’ll look for articles or comments on the internet, social media, TV, or elsewhere that helps support their fears. They won’t look for information that’ll help calm their fears. While it’s important to not dismiss the fears, it’s important to gather all information to come to an informed decision. It’s likely that what they believe will cause the next recession and/or bear market won’t be the main catalyst; it’s likely to be something completely different.
Our final thoughts—don’t run
The data is showing a slowdown in the U.S. economy and abroad, which will also likely impact the Canadian economy. However, it’s important not to panic and have a knee-jerk reaction. One of the other key rules when coming across a bear in the wilderness is not to run away, and that applies to investments. Take a step back, survey the environment, remember or revisit the plan, and stay on course.
‘Investing is like soap: the more you touch it, the smaller it gets.’
Lastly, some food for thought…
Imagine if 7 years ago you had cash on hand to invest and I had a crystal ball that could predict future events, except for the price of the S&P 500. If you asked for my predictions, I would say:
Donald Trump will be elected as President of the United States (the world’s largest economy and stock market)
BREXIT will happen resulting in the United Kingdom leaving the European Union
President Trump will enter into a trade war with China
A war of words between President Trump and Kim Jong-un
ISIS would control portions of the Middle East
We will see negative oil prices of -$35/bbl as measured by WTI.
The Yield curve will invert
Election results will be contested.
We will have a global pandemic and governments all around the world will implement severe lockdowns and travel restrictions
There will be wave after wave of the virus sweeping through the whole world
We will see supply and labor shortages in virtually every industry
Most people will be working from home for at least a year, seeing their colleagues digitally the entire time
Russia will invade Ukraine again and will attempt to take the capital Kiev.
If I told you these events would happen, there is a good chance that you may say “No thanks to investing! I’ll just stay in cash”.
Meanwhile, during that period of time the S&P 500 has nearly doubled at 98% not including dividends at an annualized rate of return of nearly 10.0% over the past 7 years including the recent sell-off!
With investing, it’s not to wish for a crystal ball, but to wish for an iron stomach!
We are here for you, only a phone call or email away. Please reach out with your questions or concerns. We are always happy to help you!