“The stock market is a device for transferring money from the impatient to the patient” – Warren Buffet.

Patience is most needed right now.  

Year-to-date market performance has been challenging for stock and bond investors alike.  Equity markets threw a strong head fake during the quarter, delivering a false rally, that gave back large inter-quarter gains made since the June close. The S&P 500^® Index had rallied six straight weeks, posting gains of 17% and the Russell 2000 Index gains of 23% from the June lows on resilient corporate earnings, signs of a possible peak in inflation, and hopes that the Federal Reserve may end the rate hiking cycle sooner than markets initially expected.  On the quarter, the S&P 500 finished down 4.9% and the Russell 2000 down 2.2%.

This quarter, investors faced a tough macroeconomic backdrop and an unyielding hawkish Fed policy.  Heightened volatility ruled the day across all asset classes as inflationary pressures, supply chain challenges, consumer sentiment, and geopolitical events combined, and increased the uncertainty in the direction of company earnings. Most prominent of concern, domestically and internationally, is when signs of lower inflation will emerge to allow the Federal Reserve to pause its dramatic rise in the Fed Funds rate. Though there has been some moderation in inflation, economic and price data continue to support the Fed’s policy of higher rates. 

Debate remains on whether the Fed can navigate the U.S. economy to a soft landing or if a more challenging recession is likely. The jury is out, but the trend is certainly lower as consensus estimates for this year have declined to real GDP growth of 1.6% and estimates for 2023 have been lowered to 0.7%.  Moderating economic growth, cost pressures and higher interest rates have combined to pressure company earnings estimates and the multiples which investors are willing to pay for those earnings.  

In an ironic, though not unusual twist, negative economic data is welcomed with positive market moves.  With the heightened concerns over inflation and interest rates, bad news is good news if that lower economic growth allows the Fed to pause and possibly lower rates. 

Looking forward, market volatility will likely continue to be dependent on the Federal Reserve’s view of inflation and the degree to which rate increases will be required to bring it toward their stated goal of 2%.  This tighter monetary policy will begin to weigh on economic growth, along with higher costs, resulting in pressure on corporate earnings. As the future is unknowable, investors must wrestle with how much these will be impacted and how much they are willing to pay for future earnings. The key to all of it, in our opinion, is the rate of inflation. When there is clarity on its moderation, markets will likely find their bottom. 

Fortunately, we are currently seeing numerous commodity and goods inflation indicators roll over as demand and supply have caught up to each other over the past few weeks.  Supply chain challenges also continue to moderate as the flow of goods and shipping prices continue to improve.  Though this moderation has not flowed through to a great degree in the headline CPI numbers, the data suggest it is just a matter of time before price declines begin to be reflected. 

A key question is when the Fed will begin slowing restrictive policies and ultimately cutting rates.  Investors currently feel that any timeline for this will be the 2^nd half of 2023 at the earliest.  As historically been the case markets tend to rally ahead of improved economic conditions which could bode well for market performance.

To navigate this environment, we acknowledge shorter-term market realities, but are seeking to take advantage of opportunistic declines in companies we believe will prove profitable for the portfolio over time.  We will be intently evaluating existing holdings and new ideas for insights on their ability to pass through costs and/or reduce operating expenses to maintain margin while creating the catalysts to drive future returns.  Valuations, dividends, cash and debt levels are critical assessment components of our investment decision process.     

Many studies have shown that missing the top-performing days of any recovery significantly reduces overall long-term performance for investors.  Data from Standard & Poor’s shows that over the last two decades, an investor who stays fully invested yielded a 9.5% return, and if the investor missed the best 20 days, the return would be 2.6%.  Though markets are likely to continue to be challenging for the foreseeable future, it is exactly the type of environment that provides the base from which future returns are realized.

We acknowledge the anxiety these markets are creating.  Our team is working diligently to navigate this challenging market with the experience gained over multiple market cycles.  From this, we are cautiously seeking opportunities for our investors and with humility and knowledge that the future is never certain; we also remain confident in our strategies which have provided solid returns over many years.

As always, please don’t hesitate to contact us as we strive to serve your needs. We are appreciative and grateful for your confidence. 

Sincerely,

Peter J. Connors, CFA

President

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