How War, Omicron, and Inflation Impacted the Markets in Q1 and What Lies Ahead
After the stock market hit record highs at the end of 2021, we entered 2022 on a cautious note. We believed the Federal Reserve had not done enough to rein in inflation, hitting 40-year highs as rising demand from U.S. consumers – who make up two-thirds of the economy and have record-high net worth – crashed into inventory shortages caused by supply-chain and labor-market disruptions.
But we hadn’t fully anticipated the events that would pose even greater risks to the market in the first quarter, including a new surge in Covid-19 cases from the Omicron variant, the Russian attack on Ukraine, and skyrocketing oil prices.
On February 22, the Standard & Poor’s 500 Index closed 10.3% below its December 28 high, marking the first correction – a drop of 10% or more – since the early days of the pandemic two years earlier. After falling a bit more, the market mounted a partial comeback starting March 8 and ended the quarter down 4.95%.
Amidst this upheaval, we maintained our long-standing commitment to companies with strong revenue growth, a history of accurately predicting revenues and earnings, are well managed and in strong financial shape. We also like dividends.
We made some tactical changes as events unfolded during the quarter.
As we saw the Russian buildup circling Ukraine, we added to our position in defense contractor Lockheed Martin on March 8. On March 14, Germany announced it would buy a contingent of Lockheed F-35 fighter jets.
Because of rising inflation and supply-chain issues, we have generally steered clear of companies that depend on raw materials or goods purchased internationally unless they can pass on price increases.
We sold our shares in Boeing immediately after a Boeing 737-800 crashed in China in March. We would like to get back into the aircraft maker/defense contractor at some point but could not take the chance of holding it, considering what happened with Boeing’s troubled 737 MAX, which is a different plane.
We believe pharmaceutical companies have that ability. During the quarter, we established a position in Eli Lilly, which has a wonderful patent portfolio, increased our position in AbbVie, and maintained our holdings of Pfizer.
Although Apple relies on manufacturers worldwide for parts and assembles most of its iPhones in China, we continue to like Apple because it has strong recurring revenues, pays a dividend, and buys back tens of billions of dollars worth of stock each year.
As natural resource plays, we bought shares of Exxon Mobil to go along with our position in Chevron and continue to own gold through the iShares Gold Trust.
We sold some retailers, thinking that once all those cargo ships get unloaded, they could end up with more inventory than they wanted and would have to start discounting. We are also concerned that U.S. consumer spending could be pinched by inflation.
Reflecting our cautious stance, we ended the quarter with more cash in all of our strategies but are always looking for opportunities in any market.
We anticipate the Fed will move aggressively if belatedly, to fight inflation. We expect it will raise the federal funds rate six or seven more times this year, in addition to its quarter-point increase in March, the first since 2018. Three of those increases could be a half-point instead of a quarter-point, which would bring the target federal funds rate to around 3% by year-end.
Inflation, however, is likely to drop only modestly to the 7% range by year end compared to 7.9% in February.
We think the market, at the moment, has anticipated and absorbed this inflationary outlook.
The wild card is the war in Ukraine. If it continues to put upward pressure on oil and metal prices, that could accelerate inflation. Many companies have halted or scaled back their operations in Russia, and we won’t know how those reductions – and any currency conversion issues – have affected them until they begin to report quarterly earnings.
We are also concerned that globalization, which has been strained by the Covid-19 pandemic, could become fractured if tensions between the United States versus China and its allies erupt into a trade war. For this reason, we favor companies that are either more domestically focused or that source and manufacture goods in multiple countries and regions.
We will continue to monitor every position in our portfolio and add selectively where we have a high conviction a company can get through this challenging period, as we have done in previous times of high uncertainty.
Although we generally use a longer-term approach, we also use refined technical indicators to give us guidance on entry and exit points. When we see a company – and the sell-side analysts are saying buy, buy, buy – but the technicals are horrible, that’s a clue we might want to reduce or eliminate a position.
We ducked out of Walt Disney in the first quarter based on its technical chart patterns but would like to get back into it.
We want to ensure our portfolios are balanced and well-diversified across sectors and industries to protect against the unexpected. We remain cautious short-term but more bullish long-term.
Our clients rely on us to find high-quality companies and fixed-income investments that are trading at attractive prices due to market dislocations. Money that leaves the market doesn’t evaporate; it must go somewhere. Our job is to be in those places ahead of the crowd.
We thank you for trusting us with your money and appreciate the opportunity to work with you. Don't hesitate to get in touch with us directly with any questions or to discuss portfolio strategy.
All the best,
Bruce and Leon
Nollenberger McCullough Investment Advisors
Performance - Trust - Experience
Bruce Nollenberger
415-287-5100
brucen@nollmac.com
Leon Wiatrak
415-956-8700
lwiatrak@nollmac.com
Nollenberger McCullough Investment Advisors
100 Shoreline Highway Bldg B, Suite 380
Mill Valley, CA. 94941
415-956-8700 or 415-287-5100
www.nollmac.com