Company Updates

Q1 was full steam ahead for Cordhaven Capital Management as we dove head first into developing our new website which will published later this quarter. Now that we are more settled into our new office, we are encouraging clients to come in and visit the new space to review your quarterly report with us. Whether it is in person or via videoconference, we look forward to meeting with you.

While we continue to improve our services to you as a client, we are also hyper attentive to the events currently unfolding in the world and what they mean for your portfolio. There is a lot of noise buzzing in the news at the moment and we hope to be your beacon you can rely on when navigating these complexities.

There is a lot of noise buzzing in the news at the moment and we hope to be your beacon you can rely on when navigating these complexities.

Market Perspective

Key Metrics

Early in the quarter, the assumption for the year was the Fed would hike three to four times throughout 2022 as the job market was strong, the economy was expanding, and inflation was running hot in a post stimulus period. These assumptions remained true, but were quickly exacerbated by the Russian invasion of Ukraine. The conflict posed two major structural issues with global supply chains:

• The EU gets about 40% of their natural gas from Russia which means conflict with their ally, Ukraine, translates to a massive supply shortage that ripples throughout the rest of the world and sends energy prices to abnormally high levels
• Ukraine and Russia make up a large portion of commodity production such as wheat, corn, and sunflower seeds which means disruption to those exports leads to food shortages around the world and skyrocketing prices

Early in the quarter, the assumption for the year was the Fed would hike three to four times throughout 2022 as the job market was strong

Together, these two issues, along with other implied supply chain complexities, created an afterburner surge in inflation. Inflation went from 7% at the end of 2021 to 8.5% at the end of March. With this new paradigm, the Fed decided to announce a quarter hike in March as well as tell the market to expect seven hikes throughout the year with the possibility of half point hikes. The Fed made it clear that “price stability” was its number one priority and expected inflation to peak late in 2022 and cool off into the end of the year.

Chairman Powell also mentioned the labor market was too good and wanted unemployment to be closer to 4% vs the 3.6% it measured in March. While this notion seems odd, having too low of an unemployment rate can fuel inflation further and cause a decrease in productivity, leading to stagflation if left unchecked. The current labor market bodes well for employees asking for raises or shifting jobs, but employers are struggling to find qualified employees and lower wage jobs remain unfilled. Despite the lack of workers available, manufacturing continued to expand between roughly 57% and 58% over the first quarter and GDP etched a reading of 6.9% for 2021 with expectations around 2% for Q1. The backdrop of a healthy labor market, expanding GDP, and elevated inflation put consumer confidence on an edge as the consumer weighed rising prices versus higher wages and ample job opportunities. Over the first quarter consumer confidence remained healthy ranging between 105 and 113 but showed early signs of deterioration.

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.

GDP will likely take a breather as well as rate hikes usually cause a slowdown in economic expansion. This will be the main challenge the Fed faces, and if it pushes rates too high, while at the same time shrinking its balance sheet, the economy could roll over into a recession. We aren’t calling for a recession at the moment but are on high alert for “cracks in the wall.” In tandem with the potential for a slowdown, we are mindful that the Fed may raise rates too far but not curb inflation which would lead to a stagflation environment. Over the next quarter manufacturing PMI should remain strong, but the consumer may begin to lose confidence as the Fed marches along the rate hike path.

Market Sentiment

Q1 began with headlines cooling off from the Omicron surge experienced in late Fall/early Winter. The focus had moved from case counts and vaccination rates to inflation and rising rates almost exclusively. With the labor market steadily improving, and inflation capping the previous year at 7%, markets were pricing in 4-5 rate hikes over the course of 2022 as the Fed made it clear inflation had risen beyond levels it previously anticipated. The expectation of rising rates led to a significant selloff in tech names and specifically high growth names whose valuations were directly tied to their previously low discount rates. The selloff persisted with some names down 40-60%, dragging the Nasdaq into bear territory and S&P 500 into a correction. Inversely the energy sector continued its strong performance following a breakout year in 2021 fueled by inflation and strong demand for oil.

Just as the dust was starting to clear on the tech selloff, headlines surrounding conflict in Ukraine began to fill news outlets across the world. Early reports that Russia would invade Ukraine due to strengthening ties between NATO and Ukraine were met with conflicting commentary and doubt cast that Putin would go through with such action. As events along the border of Ukraine developed further, it became clear that some scale of intervention by Russian forces would be likely. The market digested this information with little reaction at first, likely discounting the possibility of a resolution occurring before any military conflict ensued. This optimistic attitude quickly dissipated when Russia formally recognized the Donetsk and Luhansk people’s republics, followed by an advancement into those regions. Shortly after, despite claims from Putin that Russia had no intentions of moving further, a full-scale invasion of Ukraine commenced and the world watched as Ukrainian cities were met with missiles and tanks.

As events along the border of Ukraine developed further, it became clear that some scale of intervention by Russian forces would be likely. The market digested this information with little reaction at first, likely discounting the possibility of a resolution occurring before any military conflict ensued.

Oil prices skyrocketed and inflation ran hotter around the world, stoking fears this new conflict could be the beginning of something even bigger. While the market was already shifting towards more defensive names due to the pre-determined rate hikes, the Russia-Ukraine conflict exacerbated this change, and the dichotomy in performance between tech and energy grew. No longer did the market believe it was just a pause in growth names, but instead, a bigger shakeout was likely in store.

Moving into Q2 and looking through the year, the market is now focused on the potential of a recession due to the impending rate hikes. It is widely felt among the Wall Street crowd that the Fed is going to have a difficult time engineering a soft landing as the economy and market have been elevated by artificial government programs In other words, the chicken is now coming home to roost. The last remaining positive impacts of stimulus are wearing off and reality is setting in for the market that positive cash flows and healthy balance sheets are back in favor. This sentiment will likely hold for the majority of the year but opportunities will exist as the market enters a price discovery mode for high growth companies.

From a higher level view, looking out a few years, the world will likely move from an advancement in globalization to a retracement, and a move towards local sourcing. The supply chain issues that have been highlighted from COVID-19 and now the war in Ukraine, are causing companies to place premiums on reliable, safe supply. This can already be seen with many companies moving manufacturing back to the United States with the threat of a Chinese conflict gradually rising. This trend should bode well for the U.S. economy in years to come, but companies will experience short term pain repositioning their supply chains and paying premiums for domestic sourcing.

Performance Breakdown

As a whole, the market experienced a retracement after a solid performance for 2021. The Nasdaq led the way down with the S&P 500 and DOW Jones following behind it. Inflationary hedges such as energy and utilities fared well with energy returning 38.47% for the quarter. Communications and Consumer Discretionary were the worst performers of the quarter as rising rates weighed on high growth social media names and inflation threatening discretionary spending.

Energy should continue to hold its own but will likely cool down sometime in the second half of the year. Defensive sectors like utilities, materials, and staples will be a buoy for portfolios throughout the rest of the year as market volatility persists. Later in the year we could see a setup for growth names to take hold again and catch a bid moving into the following year.

Defensive sectors like utilities, materials, and staples will be a buoy for portfolios throughout the rest of the year as market volatility persists.

Investment Themes

Looking Back

At the start of the quarter, we maintained our positive stance on energy with the idea that sometime in the middle of year we would likely rotate back to higher growth names as interest rates settled. This strategy shifted as the war in Ukraine presented a longer timeline for growth names to move back into favor. Due to this shift, we further lightened our growth names and put cash on the sideline as well as further allocated towards defensive names. Earnings being reported in the first quarter were still strong which gave us confidence the market still had legs to it. Below are a few charts we found insightful over the quarter:

Investors tech allocation falling to the lowest levels since 2008.

While it is possible the Fed tightens too far, credit conditions are still a long way away from being historically “too tight”.

Looking Forward

Over the next quarter we will likely keep our defensive tilt adding select names that hedge against a rising rate/economic slowdown environment. One specific area we feel has potential with the current geopolitical situation is in military defense names. In the past, the U.S. has played the role of world police and in most cases heavily backed or directly intervened in global conflicts. The war in Ukraine has shown the world the U.S. is no longer willing to go fight for just any given cause, no matter how impactful. This is significant because other countries now feel they could be left to fend for themselves should conflict occur. This has led to many EU countries upping their defense spending significantly. We are looking for opportunities in the defense sector and specifically in the high-tech segment.

One specific area we feel has potential with the current geopolitical situation is in military defense names.

Beyond this we see the multiple compression trend in high growth names as an opportunity to own quality growth names for the long-term. While we expect this inefficiency to fully materialize in the second half of the year, we are cognizant that the market can move quicker and are remain ready in such an event. We are also looking for opportunities domestically for battery storage companies and nuclear energy names as the EU draws back from Russian energy dependence.

From a high-level view, the market is in a period of price discovery as the dust has yet to settle on the geopolitical climate and interest rate paradigm. We will protect portfolios in the short term from volatility associated with these topics and look to exploit opportunities as they unfold.

We will protect portfolios in the short term from volatility associated with these topics and look to exploit opportunities as they unfold.

We look forward to speaking with you soon.