It has been some time since we saw something like what is currently going on in the markets. The last time we had this much activity that was straight down was March of 2020. We know that eventually resolved itself with a sustained push higher that made everybody forget the earlier -35% market swoon. We have now reached the correction level in the S&P 500 of -10% from all-time highs. Last year, we made the case that the best thing that could happen was for the air to be let out of the speculative areas of the market, such as non-revenue and non-profitable companies, while the rest of the market made new highs. This happened for the majority of 2021. But we are seeing the air come out of the S&P 500 right now. So let’s discuss some of what is going on right now.
We have made some moves in response to the falling markets. Two weeks ago, near the top of the market, we rebalanced our Asset Allocation models. This made sure that after the big run-up of 2021 we were not overweight risk assets if the market did roll over. A few days later, we took the opportunity that a spike in interest rates afforded us to add duration to the fixed income portion of our models. Adding duration helps if the markets roll over, as bond yields tend to fall in those situations causing their prices to increase. The longer duration a portfolio is, the greater the effect of falling yields / higher bond prices. Today, we took action to reduce our equity risk from a market-weighted fund (pure market risk) to a volatility-weighted fund that emphasizes those companies that exhibit lower volatility than the rest of the market. These are all actions that we have taken recently. We are watching to take more if we need to. We never want to be too quick on the trigger as most situations like this resolve to the upside for risk markets, and if you take too many defensive positions you will be in a bad situation if the markets begin to move higher again.
So why is the market moving this way? The Federal Reserve threatening to remove stimulus from the market in the form of low interest rates has galvanized an equity reaction. There are some other contributors, namely the saber-rattling of Putin as he seeks to relive the glory days of the Soviet Union. Also, as we have discussed in the past, corporate earnings, while good, are seeing slowing growth. The market likes positive rates of change, and while earnings are predicted to go up this year, they are slowing in their growth. This does not mean a recession, but when valuations are stretched sometimes all you need is the threat of a slowing growth rate to have volatility occur. Earnings have been good so far this season, though we have yet to hit the heart of the season. Yes, we saw Netflix get hammered, but this was not wholly unexpected. High growth stories have been punctured by raising rates, and Netflix could not ignore that their US growth rate was slowing to almost nothing after pulling forward quite a bit of demand during the pandemic. We are heading into the heart of earnings season over the next couple of weeks, and we will be keeping an eye out for what narratives begin to take shape.
And now for the good news. The high-yield option adjusted spread (OAS) has not budged. The OAS is a measure of credit risk in the marketplace as the bond market sees it. During periods of true market stress, this normally spikes. As of right now, this is stuck at pre-Covid levels, and that is a good thing. High yield bonds are often seen as equity lite. The OAS is the most meaningful part in pricing a bond like this. So when the OAS spikes, the price of the bond goes down. As you can see in the chart below, the OAS is holding steady. This means that as of now, the bond market is not too worried about the equity market’s situation.
Past performance is no guarantee of future results. Trend signals are proprietary research of Fortunatus Investments, LLC, a Registered Investment Advisor with the Securities and Exchange Commission (SEC). Reference to registration does not imply any particular level of qualification or skill. Prior to June 2014, Fortunatus Investments was a wholly-owned subsidiary of Executive Wealth Management, LLC and they continue to share common ownership and control. The data source for returns is FactSet Research Systems Inc. This chart is not intended to provide investment advice and should not be considered as a recommendation. One cannot invest directly in an index. Executive Wealth Management does not guarantee the accuracy of this data.
Quote of the Week
2021 was a record year for expletives in conference calls.
The opening sentence of a recent article from the financial research platform Sentieo. An analysis of the transcripts of quarterly conference calls detected a plethora of potty mouths last year. The coarsening of corporate conversations was attributed to a reduction in business formality and the promotion of the idea of “workplace authenticity.”
On a Lighter Note
Recently, The Wall Street Journal reported that TikTok, the video-focused social networking service, was the most visited website on the internet in 2021, surpassing even Google and Facebook. With algorithms designed to deliver a stream of frivolous videos that catch your fancy, TikTok has become extremely popular with younger people, causing some adults to worry about its influence on kids. For example, will today’s youth, conditioned by the cavalcade of catchy visuals, have the necessary attention span to contemplate more complex, weighty issues? Will every topic have to be distilled down to a series of silly videos? As a possible peek into the future of TikTok-ified education, we present “The History of Western Philosophy” as a sequence of kitty cat gifs:
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Returns are calculated as indicated below with reinvested dividends not considered except for the Barclays U.S. Aggregate Bond Index. Data source for returns is FactSet Research Systems Inc. The London Gold PM Fix Price is used to calculate returns for gold.
1 Week = closing price on January 14, 2022 to closing price on January 21, 2022
1 Month = closing price on December 21, 2021 to closing price on January 21, 2022
3 Month = closing price on October 21, 2021 to closing price on January 21, 2022
YTD = closing price on December 31, 2021 to closing price on January 21, 2022
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