Welcome to another episode of “Ethel’s Diamond Post.” Today, we are fortunate to extend the celebration of Juneteenth, for it’s a federal holiday for the second year in a row. Juneteenth commemorates the emancipation of slavery for African Americans. However, let us extend freedom to everyone who has ever been enslaved by having their birth rights restricted due to their race, religion, or differences.
Next, we send a Happy belated Father’s Day to men who serve their families through the various chapters of life. We are grateful and appreciative to our fathers for the love, resources, and wisdom they give so freely. Let’s not forget the women who have had to play both roles due to unforeseen circumstances.
Everything seems out of order from the disconnect between the capital markets, supply chain disruptions, runaway inflation, oversold housing market, and aggressive Federal Reserve monetary policy. The current economic environment feels like a tug-a-war fight between Muhammad Ali, Mike Tyson, and George Foremen. Who are the plaintiffs? We must get order in the court. In this case, the economy has three potential defendants: runaway inflation, recession, and stagflation.
Chairman Jerome Powell and the Federal Reserve are pulling out all the stops to curb inflation by aggressively executing the most significant interest rate hike since 1994. The Feds went straight for the jugular by raising interest rates by .75 basis points last week. As discussed earlier in the year, the markets did not have much time to digest the .75-point hike versus the insinuated .50 basis points. Chairman Powell suggested that more inflation-fighting measures lie ahead before year-end. The rationale for these monetary policies is to curb the historic inflation increases, but such moves could throw the economy into a mild recession. The key word is that it could versus it will. The Federal Open Market Committee states they are” firmly committed to returning inflation to a two percent objective. They are attempting to turn back the hands of time to help reduce the cost of goods and services for consumers sooner than later.
The S&P 500 officially entered the bear market territory, dropping more than 22 percent off its January peak. The tech-heavy NASDAQ has been down over 31 percent since the beginning of the year. At VZD CAPITAL MANAGEMENT, LLC, we believe the market is already discounting a mild recession until 2023. We are witnessing the transition every day by increased volatility and the inability to remain consistently green for recent trading days. Yet, fortunes will be made in this current market environment for long-term investors who views a 20 percent drop as an incredible buying opportunity.
While we can’t turn back the hands of time, we believe Chairmen Jerome Powell CAN bring inflation under control. The legendary former Federal Chairman the Federal Reserve Paul Volcker performed a similar maneuver to bring inflation under control until he broke the inflation cycle closely related to where we are today. Unfortunately, he ushered in a couple of recessionary cycles to get the job done. Perhaps, Jerome Powell is hoping to overcome inflation, just like Volcker did back in the 1970s. Mr. Powell has been transparent by insinuating that bringing inflation down won’t come easy for consumers or investors. The year-end forecast for the Fed fund rate could be 3-4 percent versus the 1.9 percent rate seen in March 2022.
VZD does not have a crystal ball, and we don’t get everything right, but we believe in active investment management and rebalancing based on the economy’s overall wellness. Negative headlines are everywhere regarding the economy’s financial health, which is responsible for the mass anxiety felt in the investment community. Consumers are worried because they are experiencing a painful cost of living increase that has not been seen in decades. The political pundits are planting a garden of “doubt seeds” to gain votes for the next election. Nobody likes seeing their net worth drop – even if it is on paper, and it is very tempting to stop the bleeding and throw in the towel. Nobody knows when the market will reach the bottom, and the bottom may not happen simultaneously for every sector. The best advice in my financial career was “being late entering after the market stops going down is safer than being too early and wrong. There have been three recent bear markets, not including this one, since 2000:
- The end of the internet bubble, 2000-2003
- The financial crisis, 2008-2012
- The trade war, 2019-2020
The average bear market lasts less than a year, and they usually rebound stronger than before. The last bear market was in 2020, which only lasted a few months.
As a contrarian, a downturn in the market is an opportunity to add good companies to a portfolio at a low price. Our dollar-cost average approach during times like this and your cost basis for each company goes down.
So, what is the game plan to navigate through these choppy waters? Recession or not, dividend kings and queens have a proven track record for success that includes over 50 years of consecutive distribution increases. The management teams have the foresight to run their companies profitably in both good and bad times. We have compiled a group of stagflation companies (a period of high inflation and stagnant economic growth like we have currently). We believe copper, oil, and renewable fuel prices will remain elevated for some time, leading various companies to increase dividends and share repurchase transactions.
The rotation towards value companies in a post-pandemic environment is unlikely linear and could be affected by extreme market conditions. We are adding more mid-cap companies with a market capitalization of $2 million to $10 billion to add additional growth companies that offer more flexibility than large-cap growth companies. Mid-cap companies are strong enough to grow and big enough to have a strong foothold in their industries. That translates into focusing on reasonably priced tech stocks, health care companies that have seen earnings resilience, and utilities are significant sectors to ride out this volatile season. We believe stagnant cash does nothing but erode during the elevated period of inflation hikes. Institutions have to deploy the capital somewhere, and the U.S. remains the investment oasis of the world. Excess cash on the sidelines is a bullish sign for the equities market. The funds will make their way back into the market, starting in the recession-proof and defensive sector and then transitioning into other industries. While past performance isn’t indicative of the future, the concept of returning excess profits to investors through dividends is a robust one. This is why in the past 149 years, only six bear markets have affected dividend payments (compared with 16 bear markets for total return).
The sell-offs present buying opportunities in energy, consumer staples, and companies that protect our country from domestic and international terrorist threats. We have identified companies that provide security monitoring for cybersecurity and malware threats for the government and corporations. Did you know that higher interest rates hurt the bond market? When yields go down, bond prices go up, and vice versa. We have seen a downturn in bond prices, so we must conduct extra due diligence to disassemble their current and future credit risk potentials. Earlier this year, we saw short-term bond funds down 3 to 4 percent and intermediate-term funds down 10 percent. Remember, inflation will erode the purchasing power of dormant cash. Rising interest rates will impact credit card debt, automobile loans, and variable rate debt holders will pay more because the loans will become costlier over time.
We will continue to provide updates regarding the market conditions as the economy undergoes this unraveling stage then we will send out more newsletters. Please note that we will be sending a change of address to everyone closer before July 8, 2022. We are planning a “meet and greet” party soon after our move.
Thank you for the trust and confidence you have placed in us. Remember that we are only a telephone call away if you have any questions or concerns.
With Gratitude,
Ethel J Davis, CEO
Nikisha L, Johnson, EMC