What a smooth ride it was as markets ran a full two years from March 2020 recovering from COVID panic while the Dow rose from the 18,000's to currently trade around 33,000, all without a correction.(1) It was time for a pullback as we noted in recent communications, and this is how the 2022 first quarter evolved. April now sees an 8% decline driven by war, interest rates, inflation and other concerns...markets are pricing all this in, creating the worst declining month since March 2020.(1)
It should be clear that "correctionless" markets are unusual. Corrections occur regularly over the course of a bull market cycle - usually every year. However, pullbacks are irrelevant - markets have consistently provided stellar long-term returns that far exceed these intra-year declines.
2021 and Steroids
There is no question that there were pockets of excessive speculation over a wide spectrum of investment markets in 2021. This was concerning to us - we were unable to find reasonably priced individual stocks - valuations were excessive, and last year we lightened up on the overpriced large growth sector.(2)
The 2021 economy was percolating from a cash boost to consumers courtesy of the Federal Reserve (low interest rates) and the Treasury Department (checks in every mailbox). Cash infusions so significant that they were the equivalent of adding another 30% to the economy.(5) Spending picked up, investing picked up. All the cash sloshing around created a setup for the "wealth effect" - the phenomenon of consumers and investors feeling flush with confidence, stirring a desire to spend and risk their cash.
With that sort of economic steroid, it is no wonder that consumers were feeling giddy and speculation in markets swirled. Large growth stocks were one of the beneficiaries of this mania as the FAANG stocks (Facebook, Amazon, etc.) ruled the market. Just this handful of stocks fully represented 20% of the total valuation of the S&P 500 by year-end. The other 495 stocks made up the rest.
It should be no surprise that the most speculative areas of the market - meme stocks, crypto currencies, SPAC's (investment vehicles that invest in yet unannounced, unknown companies), smaller speculative stocks - are the ones plummeting back down to earth now. For example, small stocks are down 24% from their highs, while the S&P 500 has declined 10% less.(1) Investors can stay away from these risky, over-priced, volatile choices and generate perfectly fine long-term returns in high quality securities.
In the meantime, our title above refers to the stealthy transition of funds flowing this year to large stodgy value stocks away from large 'growthy" stocks. Stodgy value stocks are outperforming large growth stocks by a huge 14% year-to-date.(4) This may have gone unnoticed by investors chasing last year's winners. This transition has been very ideal for our high quality individual stock strategies.
False Promises - The Market Opioid
We have anticipated volatility for quite some time, and have elaborated on why midterm election years are volatile, but the risk for investors is to react to this volatility. Last month, we outlined the poor outcomes of trading into and timing downturns. A library full of studies shows that timing markets, panic during market declines, and firms promoting "safe" trigger-selling strategies have consistently provided subpar long-term returns. The Dalbar investor behavior studies confirm that over long 20 year timeframes, investors selling in panic reduce their long-term returns by over 1/3, which almost always means the difference between accumulating a healthy nest egg of millions and lifetime financial disaster.(3)
The start of 2022 should be no surprise. We have noted the absence of corrections over the last two years and that midterm election years are notoriously volatile in the front half of the year, so recent volatility is right on par with history. Current market declines are right at the level of historical annual intra-year pullbacks. (See the study we reference in our prior month commentary). We anticipate markets settling in the very latter half of this year. In the meantime, if cash is available, we will take advantage of these declines and purchase high quality securities to bolster client long-term returns.