June 2022
Turbulence is Okay
Christopher P. Lorenz
Early this morning, as I watched international markets to glean some insight on how our markets would open, an old maritime quote came to mind: “the floggings shall continue until morale improves.” I searched the internet for its author and found that it isn’t attributed to any one captain or naval officer, but it has lasted the test of time because it highlights how difficult it can be to change pervasive negative sentiment. But, sometimes negative sentiment is actually a catalyst for change.
In March of 2020 my screens looked as red as they do this morning, so I started calling clients to discuss what I referred to as “maximum pessimism” and that it was possibly the time to set aside the fear and structure portfolios for a recovery.
Investor sentiment took yet another blow with Friday’s release of the Consumer Price Index, showing that inflation remained at peak levels in May. Many had hoped, as did I, that May would show inflation softening. While the news remains bad, the May data is in the rearview mirror, and what is important is the current data in June and beyond. The first part of June has seen softening of important categories, like used cars and building materials. Lumber markets, which I watch closely, have been halved in many parts of the country and mortgage applications have slowed taking some of the froth out of the housing market. So, despite these data moving in the right direction, Friday’s CPI release pushed the pessimism gauge to the moon.
If you read anything about markets this weekend you know that finding an optimistic investor was akin to finding a unicorn. It once again feels like “maximum pessimism.” Does that mean I think we are at the bottom of this pullback, no, but it does mean that I believe it’s time to pivot. In my experience “maximum pessimism” is when prices for the highest quality companies, start to drop like the poorly run companies. Microsoft, Home Depot, Blackstone and many others are off more than 20%, yet their business outlook remains healthy. As a long-term investor looking out several years, discounts like these are important opportunities.
Inflation is sticky and takes time to work through the economy, even if governmental efforts are successful. Investors will price in the improvement before the data shows any and smart investors won’t try to “pick the bottom.” I am pivoting my outlook towards structuring portfolios for a recovery. I am not shifting strategy dramatically, but the risk reward ratio improves when stock prices reflect maximum pessimism. I have been dollar cost averaging many positions as the market has moved down and some stocks are now trading at prices that are far below what I believe is their intrinsic value.
Current pessimism is in indicator of how hard it will be for the Federal Reserve to slow the economy without pushing it into a recession. As investors, we need to remember that markets move before the data is received and thus stocks will rebound before the economy rebounds and that is the positioning we want in our portfolios. This bumpy ride isn’t over, and we will need a few months of positive data before we know the impact of the efforts to curb inflation. It is impossible to know when that reversal will commence, or the “bottom” is in place, but my experience with market pessimism gives me comfort that as a portfolio manager its time for me to pivot from bracing for impact towards looking at the opportunity of forward returns.
Please call, email, or text if you want some details about how this pivot will be implemented. I am not making dramatic changes right away. We will likely see more downside as we wait for better inflation data and market bottoms are a process not a moment and, in that context, I am looking forward and starting to reposition for better times.