TBG Market Color August 2022
We are now officially through two quarters of operating results in 2022. Below we provide a road map on where we think investors should focus from here.
Our summary thoughts here with more detail below:
- We anticipate a more stable market in the second half of the year.
- After a tough first half to start the year across the board, the market has rallied to start the second half driven by: oil and commodity prices falling (good for consumers and company freight costs), better than feared Q2 company financial results, and attractive public equity valuations vs. other asset classes.
- While there will continue to be debates about inflation and where economic growth goes, we believe the Federal Reserve will work to keep markets range bound through the year to protect further economic fallout while keeping asset bubbles and inflation in check.
- Assuming commodity inflation continues to moderate, we do not anticipate another major stock market reset this year.
- The broader societal themes are largely the same, it's the share prices and valuations that have fallen.
- Putting this altogether, we think this is an attractive time to invest in companies with strong potential into 2023 and beyond.
- Our strategy is to make targeted investments in companies that have strong long term potential, are executing on a plan, and have reasonable valuations.
- We have had success investing following this playbook with example investments below.
The Bycoff Group
Since July, public equity markets rallied with the S&P 500 and Nasdaq re-tracing levels from -20% to -10% and -30% to -17%, respectively. In addition, growth indices have begun to outperform value indices once again in the last two months. Clearly, there is a lot going on beneath the surface. Valuations across the entire market were pressured due to inflation and the Fed’s subsequent action of raising rates. Many companies missed Wall Street estimates as they were unable to keep up with the fast pace of revenue growth over the last two years (Netflix) or suffered from cost pressures (Walmart or Amazon) or both (Meta). The market priced in slower economic growth across the board causing even commodities and banks to fall. Below we provide a chart showing asset class performance at the trough as well as year to date. These economic conditions spared no asset class or company, blue chip or small cap.
% Return over H1'22, H2-to-date and Year-to-date
Why Did The Market Rally?
We think the answer lies in commodity prices coming down, company results coming in better than feared, as well as attractive valuations.
- Commodity prices have started to fall. The price of oil is down about -25% from June highs of $120 per barrel to about $90 today. Wheat is also off about -35% from prior highs. We think this is an important signpost that inflation can be controlled, as oil and commodities account for a large portion (~30%) of the government’s inflation measure. Lower oil not only lowers freight costs for companies but also leaves consumers with more money to spend.
- Mixed company results in Q2 were largely priced in. The S&P 500 had sold off -20% into Q2 results but forward profit estimates have only come down -3%.
- Public equity markets represent an attractive valuation vs. other asset classes. Cash flow yields of many companies reached 6-10%, and those levels are quite compelling considering many equities grow cash flow over time.
What Has Worked this Year?
We have stuck to fundamentals this year and kept a long-term focus which has paid off nicely. We have kept allocations relatively steady as we felt meaningfully decreasing growth positions at a time of trough valuations was not the right call. We did add hedges in commodities to protect the portfolio and allow us to feel more comfortable holding growth positions. Hence, we have benefited from the rally in the past few weeks.
Examples of investments made:
- Solar supply chain companies: In our annual outlook, we called out clean energy as an area we liked for 2022. We liked the strong long-term trends and reasonable valuations. This year, things have gone better than expected as new markets in Europe emerged on account of the Ukraine War and the US passed major legislation. The investment has been a major positive contributor both relatively and absolutely.
- Hotels and lodging: Another area that has been successful is our position in hotels and lodging. Our investments in the space have benefited from strong US leisure demand to start the year coupled with improving demand from international and business travelers.
- Social Media: One idea that has not worked yet – an overweight of social media. Given the importance in our society, we expected results to hold up better and the market to be more willing to focus on long-term prospects given relatively reasonable valuations. This thesis has not played out this year.
Where to Focus from Here?
We believe markets will be more stable in the second half of the year. We foresee a market that could be especially strong for our strategy of investing in targeted companies. Ultimately, we believe the themes are largely unchanged, it's just the valuation that have fallen. That creates a reasonably good set-up for long-term minded investors.
Major market indices could be range bound as the Federal Reserve continues to raise rates to ensure inflation stays in check and no asset bubbles form. We acknowledge short term share prices and company results have been hard to predict this year. In the span of three weeks from late July to mid August, Walmart went from lowering forecasts for profit for the entire year only to raise them back higher by $12B this week. However, as Walmart noted on their quarterly call this week, falling fuel not only helps reduce their own shipping costs but also could lead to lower food inflation as well. While forecasts for 2023 growth could fade a bit, barring a major event we do not see another major market reset in the second half of the year. All of this should lead to a more stable market over time and a beneficial one for long-term investors.We are looking for companies that are both executing in the near term with a consistent story and have solid long term growth potential. Digitization is continuing to take hold in industries from our cars to sports gambling now done on an app. Companies that can get people to willingly spend money on their products remain interesting opportunities. Many companies' share prices have bounced back but are still substantially below their prior highs in 2021 and the underlying companies are more developed today. We are focused on finding and investing in those companies as we believe over time and with execution and growth they could eventually exceed those prior levels. Much like Amazon did back in 2009, when it fell by over 50% before reaching prior levels in about a year and eventually exceeding them.