“If one does not know to which port one is sailing, no wind is favorable”–Lucius Annaeus Seneca
We often compare sailing to investing. It is in choppy waters that a sailor’s mettle is tested. In this note, we’ll highlight the items we are monitoring as we navigate the first economically driven bear market since 2009.
In the beginning of the year, we identified a core investing theme as being the Fed’s intention to taper its bond purchasing program and raise Fed Funds rates to counter inflationary pressures. Since January the Fed has raised rates three times from near zero to a range of 1.5%-1.75%. Inflation, which is currently 8.6%, far above the 2% Fed objective, has a regressive impact on consumer purchasing power. Until there is evidence of moderating inflation it is safe to bet that the Fed will remain aggressive raising rates even if it risks causing a recession. In the 1Q 2022 GDP declined 1.5% from a strong +6.9% in the 4Q 2021. Should 2Q GDP turn negative the economy would meet the definition of a recession. Clearly the Fed is walking a fine line as it works to fight inflation.
What does this mean for the stock and bond markets? The valuation of the stock market has contracted from the low 20’s at the beginning of the year to 15x projected P/E ratio for 2023, which suggests stocks are cheap. However, if the economy enters into a recession then it is likely that earnings forecasts will fall and the market will continue to face a headwind until the earnings outlook stabilizes. Regarding the bond market, the yield on the 10-year treasury has risen from 1.49% at the end of 2021 to its current level of 3.2%. As yields rise, bond prices decline so it has been a very tough year for bond investors. We would not be surprised to see the 10-year treasury yield approach 4% by the time the Fed gets inflation under control.
We remain confident the businesses owned in client portfolios are well positioned to weather this challenging environment. None are dependent upon external capital to fund operations. The companies we own are generating excess cash flow, managed by smart management teams, and positioned to navigate this volatile economy and market. Regarding fixed income, we have taken advantage of higher short-term rates to sell money market funds and ladder short term treasuries to capture better yield. With new stocks, we will seek to add companies with good longer-term outlooks as volatility persists.
Thank you for entrusting Ayrshire Capital Management LLC with the management of your money. We look forward to speaking with you in the coming weeks.
JM Sam Nevin, Jr.
W. Joseph Ryan III
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