Sometimes, an investor is simply out of step with markets and that’s the way it has been of late for the team at Forge First. Aside from our ongoing constructive stance on Energy, given our concerns about stagflation, each of our two funds has maintained their exceedingly cautious net exposures. Obviously, given the strong countertrend rally in equity markets, this positioning hurt the funds during July. After reviewing the numbers, this note will discuss why we remain cautious towards stocks, including a fact check on the outlook for inflation.
While we all knew the party was going to end at some point, few expected such a reckoning to begin during the first half of 2022. In our year-ahead commentary, published in early January, we cautioned investors that 2022 could be a down year for markets based on the impact of sticky supply chains and weakening economic growth. However, we saw market weakness in H2, not H1. The principal reason for the earlier-than-expected shellacking of all things financial was clearly the Fed. The central bank of the U.S. waited far too long to admit inflation wasn’t ‘transitory’ and then shocked the market with a 180-degree turn during the 2nd week of January. Yet, talk is cheap (except for the negative wealth effect on investors) because, as you can see from the white line on the 15-year graph below, as of June 30th, the Fed has yet to begin to shrink the size of its balance sheet. But let’s not get ahead of ourselves, and prior to reviewing the second half outlook for markets, let’s recap H1 and discuss why June was so ugly.
One of the well-known quips about investing is that there are fewer things more humbling than markets. In last month’s commentary, we mused that by Labour Day markets would sense a pending shift by the Fed, be it dovish or hawkish. Then, lo and behold, near the end of April, in light of weakening Chinese data and plummeting U.S. housing data, market psychology assertively pivoted towards growth fears from concerns about inflation. The impact of this shift dominated market action during May, especially after Target Corp. (TGT.US) and Walmart Inc. (WMT.US) tabled sizable overhangs in their inventory positions and the latter joined Amazon.com Inc. (AMZN.US) in announcing a hiring freeze; two companies that employ three million people. As a result, markets exited May amidst a “perfect storm” of P/E multiple compression, profit margins that are rolling over and the rising prospect that revenue growth will roll over thanks to supply issues and the growing prospect of an economic slowdown.
Long-only investors endured a rough April as stocks unwound 100% of their H2 March rip higher, while bonds remained in the proverbial woodshed. NASDAQ suffered its steepest one-month decline (-13.24%) since October 2008, with April ensuring the S&P 500 is off to its 3rd worst year to date (-12.92%), with only the auspicious years of 1932 and 1939 having been worse. Here at home, the total return loss of -4.96% pushed the TSX into the red for 2022. For investors, the timing could not have been worse given equities as a percent of U.S. household assets stood at an all-time high of 41.9% at year-end 2021. The combination of rich valuations and fears towards inflation and growth, catalyzed this rout.