Tudor August 2022 Commentary
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Valuations Matter

One more reason to enjoy the hot, dog days of summer: markets have calmed after a first half riddled with volatility.

Early 2022 market declines were no surprise. Since late 2021, we've communicated mid-term election year first halves are notoriously volatile...this one had a war and inflation and interest rates thrown in to make it more roller coaster.

What made declines more severe this year were out of left field anomalies. These include the Ukraine war, worldwide inflation (45 countries are raising interest rates)(4), and the aggressiveness of the fed as they battle "inflated" levels of inflation. As interest rates rise, all assets need to be re-priced down to reflect these higher rates - always true.

We noted in our June commentary that Markets Already Reflect the Risks. Like clockwork, markets stopped declining and have risen since.

2022's market declines are far from the worst first half performance in history.(5) Large declining quarters and first halves have historically been followed by large recoveries, which has been the case in recent months. Remember that rehashed media worries - recession fears, politics, interest rates, inflation - the more rehashed, the more they lose their power as catalysts to keep markets down.

Valuations: Yes They Do Matter
Asset values matter. See our housing commentary below.

They matter and they matter a lot when prices are at extremes. Overvaluation and undervaluation occur in cycles. Our individual stock filtering process indirectly tells us when stock prices are over or undervalued. The filtering process tells us this by how many high quality candidates are available for purchase at bargain prices - few candidates suggest market overvaluation and a long list of buy candidates suggests undervaluation. (For reference, we would assess current markets at average valuation levels.)

We know that the list of bargain high-quality stock candidates exploded in March 2020 during COVID declines. We also know that the list of candidates imploded to virtually none by the end of 2021. March 2020 - markets cheap. December 2021 - markets expensive. Valuation assessments have the potential to improve outcomes.

However, valuations don't immediately result in a reversing price action, so they are not short-term predictive. High valuations don't mean that prices will drop immediately - as we often say, airplanes can fly high for a long time. Likewise, cheap markets don't necessarily mean that markets will take off in short order either. Valuations don't tell you where markets will be in the next 6-12 months.

However, all assets migrate above and below a trendline of returns, and the outright madness of speculation in 2021 was bound to regress back to trendline again. In fact, markets are simply back to levels where the madness began - early 2021.(1) Even a little better. Markets ultimately found reasons to get back to reasonable levels once again.

What was Significant About June 16th?

These things happen subtly. The major indices bottomed on June 16th and have rallied significantly since. No bell-ringing. Inflection points are only apparent in hindsight. Were there any experts calling a bottom that day?

Now We Head into the Back Half of the Year

We will now be evaluating the back half of the year. We suspect much of this year's first half market-impacting news will resolve. There is no certainty that the lows of the year have been set; however, in our view, all the first half worries have been priced into markets.
$80 Trillion vs $500 Billion
U.S. household net worth is $80 trillion higher today than it was ten years ago, which is astounding. With market declines, it’s about $500 billion lower than it was three months ago, a tiny fraction of the ten year gains. Yet one of those figures has created ten times the headlines, attention and emotions in recent months.

Our reference point for accumulated assets has nothing to do with the level accumulated wealth and everything to do with the recent trajectory of wealth.

Source: Morgan Housel, Collaborative Fund, Wealth vs Getting Wealthier
Three Elements Required for
a Housing Bubble
How do you know when you're in a bubble? In this case, when bubbles are defined as highly speculative, unsustainable prices of an asset class? The harsh reality is that you know a bubble only in the rear view mirror. While one might have a "feeling" or "suspicion" that a bubble exists (and yet still have the desire to participate in them) the actual roller coaster trajectory is only known with certainty in hindsight.

As a reference to real estate as an asset class in recent years, some suggest that there are three elements to look for to determine real estate bubbles, and they are the following:

The first element is speculation: This has occurred in the last two years as investors have swarmed in to chase soaring home prices. Home flippers (remember the year 2006?) returned in force to buy in the last 24-36 months as real estate prices accelerated. Surveys suggest 38% of home buyers in recent years have been investors, nearly 4 in 10 buyers. During this period, overall demand for new housing units grew as well, but builders have not waited for qualified buyers and have instead built "spec" homes - homes without buyers in place. As a result, housing inventory has increased significantly.

The second element is overvaluation: How much income does it take to support a new home purchase when prices are at historical highs and interest rates increase? A lot more as home price gains accelerated in recent years. As we noted in our last commentary, Harvard University's State of the Nation's Housing Report stated that for every 1% increase in interest rates, 4 million prospective buyers are locked out of the market.

The third element - a bursting bubble: If home prices don't actually decline significantly, then excessive prices are not construed as a bubble.

According to the Census Bureau, after reaching an all-time US high of $457,000 in April 2022, the median sales price of new homes sold in the USA has fallen during the last 2 months to $402,400 in June 2022, its lowest level since June 2021. The August 19, 2022 Wall Street Journal suggests that home sales levels have fallen for six straight months.

Some suggest that prices will continue to decline from current levels, while others suggest they will stagnate for years. The big question is whether pent up demand of recent years will intersect with a growing inventory of unsold homes, causing prices to drop.

As we noted earlier, bubbles are only confirmed in hindsight, so passage of time will answer that question. It is interesting to note that many bubbles have occurred over a very long history of bubbles. Going back centuries - even in tulip bulbs.

(Source: fortune.com, 08/08/2022, New Home Prices Falling: Homebuilders Oversupply)
What Kind of Investment Journey
Would You Like?
5.33% Decline or 15.10% Decline?
You do have flexibility to determine what sort of investment experience you would like to have. This is why, before we begin a client relationship, we use carefully developed questionnaires that help determine client goals and comfort levels.

Most investors, as they cycle to investment maturity, step away from shooting for potential higher returns (which are usually coupled with greater risk) and migrate to the serenity of solid, less volatile strategies that provide consistent returns. A portfolio can be built to include high quality securities that have historically offered more resilience during market declines.

The irony is that you don't have to sacrifice returns when you take the meditative, less bumpy route.

In this particularly bumpy year, we looked at our database of 5,500 stocks and initially screened for those that have the highest level of financial strength - solid, well-established companies. The top 10% strongest (measured by financial strength) have declined by 5.3% year-to-date through August 12th. The lesser-ranked individual stocks declined by 15.10% year-to-date.(3) This is a significant difference in a volatile year; and a further confirmation of studies that show that the real secret to high quality stock investing outcomes is not the performance of these stocks when markets are euphoric and risk is high, but rather when markets decline. This year has once again shown that quality stocks often outperform over long investment cycles - not in supercharged bullish markets, but rather with the resilience they offer in fearful declining markets.

This is all investors need for potential outperformance: less decline, more resilience and an easier path to recovery after market declines.(6)
"The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists.”
Benjamin Graham
Dow Industrial Index

March 23, 2020 - 18,214 (2020 low)

August 22, 2022 - 33,064(1)

82% Gain
Enjoy the week...
Grant S. Donaldson, MS, CPA
(1) yahoofinance.com, S&P500 historical data, Barrons, Morningstar.com, Vanguard benchmark returns
(2) Information available upon request
(3) Value Line Investment Survey, August 2022
(4) Interest Rates Rise Around the World, as War and High Inflation Grind On, New York Times, June 16 2022
(5) https://www.wsj.com/articles/markets-head-toward-worst-start-to-a-year-in-decades-11656551051
(6) Alliance Bernstein, The Paradox of Low Risk Stocks, Gaining More by Losing Less, 2014
Past performance is not indicative of future results.  Nothing in this communication should be construed to contain a solicitation to buy or an offer to sell any security.  Some information contained in this communication has been provided by sources other than Tudor Financial, Inc., the accuracy of which is the responsibility of the provider.  Advisors affiliated with Tudor Financial are Registered Reps. of Westminster Financial Securities, Inc.,40 North Main Street, Suite 2400, Dayton, Ohio 45423, member FINRA/SIPC. If you would like a copy of our Schedule ADV Brochure, a written disclosure statement outlining our background and business practices, please contact our office.
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