by Tom Bradley
The first half of 2022 was the worst 6-month period in history for balanced portfolios. Bonds and stocks were down significantly, which is unusual in bear markets. The declines reflect an economy and market going through a massive transition. To better understand why this is happening, we need to first look at where it started.
Prior to this year, some important trends were far from normal. Central banks and governments were in perpetual stimulation mode (even when the economy was strong). Interest rates were near zero and borrowing was easy. Buy now, pay later became the modus operandi for many families and most governments.
Corporations had the wind at their back. In addition to cheap financing and energy, labour was plentiful and the cost of using the planet’s ecosystem was free, or close to it. Business was run ‘just in time’ with little slack in the system.
Meanwhile, investors were focusing on innovation and technology. These ‘asset light’ businesses, which traded at valuations reminiscent of the tech boom in the late 90’s, sucked capital away from companies providing the inputs needed to implement the technologies.
These trends were unsustainable but that didn’t make calling the turn any easier. A change agent was needed, and we got two big ones — a pandemic hangover and a European war — which proved highly disruptive to such a tightly wound, highly geared economy.
The economic tailwinds have now turned to headwinds. Labour and many inputs are in short supply and financing isn’t as cheap or accessible. Interest rates have reversed course as central bankers desperately try to catch up to spiraling inflation.
Global stock indices are down almost 20% year-to-date and many tech stocks are 70-80% below their highs.
So where does this leave us as we look forward? Transitions as major as this one take time to play out but a lot of adjustment has already occurred. And we shouldn’t forget there are many positives mixed in with the waves of negativity. The outlook for employment is good, the ever-increasing use of technology will help moderate cost increases and the middle class in Asia is growing rapidly. And private equity firms have a huge cash pile to spend.
Earnings will likely come down and debt will be a problem, but the system is in a better place than during other slowdowns. The banks are well prepared, and the U.S. consumer is not over extended (as opposed to Canadians). Loan defaults are more likely to be on the books of private investors as opposed to depositors, which is good for the stability of the financial system.
And importantly, stock valuations have fallen back into normal ranges, and investor sentiment has turned decidedly bearish (a good contrarian indicator).
Going forward, we expect the market to be more discriminating than it has been so far. Markdowns on private assets are yet to come and some weak players won’t survive, but well-financed, profitable companies, which is our focus, have a wonderful opportunity to get stronger. We’ve been slowly adding to these types of holdings, many at compelling valuations. I don’t know when markets will bottom but know that I want to own a diverse collection of leading businesses when it does. We are endeavouring to do that on your behalf.
I encourage you to read the rest of our Q2 Report, where we provide more details on our specific strategies and what we've been doing in each of our funds.
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