Last quarter was an exciting time for Cordhaven Capital Management (CCM) as it officially opened its doors metaphorically and physically speaking. Throughout last year we began the process of moving clients over to CCM and in the fourth quarter began fully operating as a standalone firm. In addition to transitioning the internal business, we also moved into a new location just down the street from where we were previously. We are welcoming anyone, client or not, to stop by and visit anytime.
As we move into 2022, we look forward to continuing our intensive focus on your portfolios as well as enhancing the overall service you experience. In accordance with delivering an enhanced experience you can expect to see a refreshed quarterly report providing additional insights into your portfolio, a new website with account access capabilities, and a handful of other smaller initiatives. Our goal is to provide you with a white glove wealth management service and we will continue to look for ways to further that goal.
Our goal is to provide you with a white glove wealth management service and we will continue to look for ways to further that goal.
Earlier in the year, concerns of inflation domestically and around the world began to pop up due to supply chain issues caused by COVID-19 all while consumers were flush with cash from fiscal stimulus. Many people early on, including ourselves, felt this inflation would be stickier than officials at the Fed were stating. As inflation continued to creep up through the year, the Fed maintained its stance that inflation was transitory and the need to raise rates was not valid. Then, at the end of November, when inflation had risen above 6% annually, the Fed decided to “retire” the word transitory when describing the current inflationary environment. It was at this point Jerome Powell announced, “We will use our tools to make sure that higher inflation does not become entrenched.” Later in December, the Fed stated it would begin accelerating the tapering of quantitative easing, citing the biggest jump in prices in nearly 40 years. Many questioned why the Fed waited so long to admit inflation wasn’t as transitory as they had initially claimed. The Fed was stuck in a difficult position because the US government had released stimulus to individuals and businesses on a level not seen since the great recession which meant massive debt loads for the US. If the Fed raised rates too early, the new debt incurred by the government would be unmanageable due to the interest on the debt alone. However, if the Fed waited and let inflation run hot, which is what they said they wanted to achieve (2.5% vs 2.0%), then the new debt incurred would be much more palatable with much of it inflated away. To put this concept in a simplistic way you can think of the following: if the debt load is $100 at the beginning of the year and there is 7% inflation throughout the year, the real cost of debt at the end of the year would be $93 and hence reducing the burden incurred. Regardless of the reasoning, inflation stood at 7% annually at the end of the year. The other consideration the Fed looks at is the health of the labor market. One of the Fed’s stated mandates is to ensure a stable job market which would have also been impacted if the Fed raised rates too early. Off the back of seeing some of the highest levels of unemployment in US history, the Fed along with the government was highly focused on getting the workforce back on track. Over the course of the year and the fourth quarter specifically, unemployment continued to fall from 5.2% at the end of August to 3.9% at the end of December. A major story in the job market was the scarcity of qualified employees. This led to desperate employers willing to pay workers well beyond what the original pay rate was. In turn consumer confidence held steady over the fourth quarter and increased slightly from 113.8 at the end of August to 115.8 at the end of December
The Fed was stuck in a difficult position because the US government had released stimulus to individuals and businesses on a level not seen since the great recession which meant massive debt loads for the US.
One of our major concerns going into 2021 was whether or not the rebound in US GDP could be maintained after the steep drop in Q2 2020 and remarkable bounce back the following quarter. We worried the stimulus injected into the economy provided a boost in the arm but could have a hangover effect once the initial benefit passed. Thankfully our concerns were not warranted and the economy continued to expand throughout the year with the conference board estimating Q4 GDP to be 6.0% (annualized rate) and 5.6% year over year for 2021. Manufacturing played a strong role as it continued to expand throughout the fourth quarter, never dipping below a reading of 60% (50% and above is considered expansionary).
Moving into 2022 we expect inflation to stick around for the time being with the caveat that some current inflationary pressures will subdue. Our expectation is the Fed will raise rates this year but not as many times as the market is currently pricing in which is around 4-5 hikes. If the Fed were to hike this aggressively, it could cause the economy to reverse course and be in danger of entering a recessionary period. Again, we don’t expect the Fed to do this but we are mindful of the consequences. We also expect wages to continue rising as labor shortages persist into the year. This should be a good setup for a healthy consumer when paired with rising asset prices. In general the labor market should hold steady for the foreseeable future with a steady pace of people rejoining the workforce due to plentiful job openings. US GDP is still expected to grow for 2022, around 4%, despite the unwinding of stimulus and rate hikes. We are keeping a close eye on GDP as inflation rises due to the threat of stagflation (where inflation remains high but economic growth and employment faulter) should rate hikes prove to be a misstep by the Fed.
In general the labor market should hold steady for the foreseeable future with a steady pace of people rejoining the workforce due to plentiful job openings.
Looking forward into Q2 and beyond, we expect inflation to peak in 2022 but remain at elevated levels into next year as the structural inflation we are experiencing is much harder to shake. The Fed will be walking a very tight rope throughout the year as it seeks to balance the fight with inflation and the potential for recession should it raise rates too quickly. We believe the Fed will stick to seven hikes over the course of the year but we also consider the chance of the Fed balking if inflation cools quicker than anticipated. If the rate hikes continue pace, which the bond market is currently pricing in, then the labor market should loosen as businesses pull back on expansion.
If the rate hikes continue pace, which the bond market is currently pricing in, then the labor market should loosen as businesses pull back on expansion.
The beginning of Q4 was represented by a renewed fear of a third major strain of COVID-19, Omicron. At the time, the US was recovering from the pandemic so the threat of a new variant meant another potential downturn in the economy. While this news would have been bad in most cases, the market paused as it perceived a potential downturn in the economy as an excuse the Fed could use as to why they would keep rates at 0%. This caused a final rally in the market for the fourth quarter as many investors figured the Fed would have to wait until the dust settled on the new variant.
Supply chain problems persisted however, which gave way to rising inflation through the end of the year. As the fourth quarter came to a close, the market shifted its focus away from COVID-19 and directly to rising rates. The new threat of rising rates meant tech valuations would have to come down dramatically which is why we have seen a selloff in the overall market and specifically tech. As mentioned above, the market is pricing in rate hikes around 4 or 5 times over the course of 2022. The current pulse in the market is a shift away from high growth names and into inflationary hedges and companies benefiting from higher rates. We feel this theme will be overplayed and present us with opportunities to buy quality names in the tech sector at compressed valuations.
The current pulse in the market is a shift away from high growth names and into inflationary hedges and companies benefiting from higher rates.
The overall market had another incredible year with the S&P 500 leading the way followed by the Nasdaq and then the Dow Jones Industrial to cover the large indices. Breaking down the market by sector shows what an incredible year the energy sector had after a long period of underperformance relative to the broader market. Real estate and tech continue to be strong sectors year after year. The defensive sectors had a more muted year, but this is to be expected in a low rate environment.
Breaking down the market by sector shows what an incredible year the energy sector had after a long period of underperformance relative to the broader market.
We are expecting another strong year in real estate and energy as well as materials and financials. The rising rate landscape, as brought on by inflation, should be a healthy set up for these sectors to fare well. Technology will likely struggle early on but has the potential for select names to rebound after an overshoot by sellers in the market.
At the beginning of the fourth quarter we remained guarded as the market showed signs of overheating with similar comparisons to 2018 when the market experienced a flash crash late in the year. Large outflows from cash into major US indices juxtaposed to extremely loose financial conditions supported our thesis. However, long-term we felt the market had strong secular tailwinds with strong corporate buybacks and a recovering US economy. With rising rates and the threat of a market correction we lightened portfolios’ exposure to tech/high growth names and added to energy and financials. We continued to be bullish on semiconductors over the fourth quarter as demand for chips continued to increase and supply remained tight but understood rising rates would be a headwind moving forward. Below are a few charts we found insightful over the quarter:
As 2022 is well underway, the rotation out of high growth companies, mainly tech, and into more value companies, specifically energy and financials, has been brought forth by the Fed’s commitment to raise rates this year. We are bullish on energy and financials over the near term but are keeping a close eye on value compression in the tech space. While there is still room for tech to adjust valuations and wash out companies undeserving of lofty multiples, we feel there will be decent buying opportunities as the market throws the baby out with the bath water and high-quality names overcorrect. We will look for value as it is presented to us but will be specifically looking at companies involved in neobanking, AI automation, raw materials needed for the green energy revolution, and the metaverse. We also are bullish on the real estate sector as home prices continue to rise across the US.
We will look for value as it is presented to us but will be specifically looking at companies involved in neobanking, AI automation, raw materials needed for the green energy revolution, and the metaverse.
Beyond these themes we are paying attention to conflict with Russia as tensions surrounding Ukraine continue to mount. While most geopolitical events have minor bearing on the market, the potential for a disruption in European energy supply could have a rippling effect in energy markets. The other potential major impact from a war with Russia would be cyber-attacks. Russia is notorious for these types of threats which could cause problems in unimaginable ways as the true power of cyberwarfare has yet to be seen. While we feel cooling heads will prevail and conflict with Russia will subdue, we are cautious.
To summarize on a higher level, we remain constructive on equities as an asset class for 2022. We are currently experiencing market volatility and some shaking out in tech, but we believe this will pass before the start of the second half of the year. If this market correction deepens to a severe bear market, the pain experienced will still likely be quick and would mark the beginning of a much longer bull regime.
We are currently experiencing market volatility and some shaking out in tech, but we believe this will pass before the start of the second half of the year.
We wish you a healthy and happy new year and look forward to speaking with you soon.