- Frank Byrd and Steve Korn
Three Pillars for 2023
Last year was an ugly year in markets. How did Fielder do in navigating it for our clients? More importantly, how are we positioning for 2023 onward? The Worst Year Including the carnage in both stocks and bonds, global capital markets lost more in 2022 than in the 2008 Great Financial Crisis and COVID combined. The blended return for stocks and bonds last year was the worst on record dating back to 1872. That makes 2022 “the biggest outlier year in history,” according to Deutsche Bank’s Jim Reid. Our Hits In navigating 2022, here are a few things we got right: We under-weighted large tech. Our preference for equal-weighting equity index portfolios paid off in 2022. The seven largest stocks in the S&P 500 were down more than 46% on average, while the other ~493 stocks were down just 11% on average. The traditional S&P 500 is market-size weighed, so those seven largest stocks drove a significant part of the index’s 18.4% decline. The equal-weighted S&P 500, by comparison, was down just 11.8%.
S&P 500 Divergence
Source: Factset, Fielder Capital Group LLC
We owned alternatives. Our clients entered 2022 with not only traditional stocks and bonds, but also commodities, natural resource equities, real estate, and alternative investments. These investments bolstered returns, providing a much-needed offset against traditional stock and bond market declines. We shunned long bonds. We’ve been worried about inflation for years, having written extensively on our beliefs that money printing would ultimately have unintended consequences. We had thus in prior years been tilting away from long-term bonds in favor of shorter-term treasuries, floating-rate private credit, and TIPs. These positions helped fortify our client portfolios against the losses in the broader bond markets once inflation arrived. (Believe it not, the Bloomberg Long-Term Treasury Index was down 29% last year). We were NOT worried about inflation (near-term). As investors fretted last summer that inflation was heating up, we said that leading indicators suggested inflation was actually rolling over. For that reason, we said we did not share the markets’ fears over near-term inflation. Rather, we remained concerned about longer-term inflation (unlike markets which price in ~2.2% inflation a decade from now). This view proved correct later in the fall. Inflation has continued to come in lower than the Fed and Wall Street had earlier feared, most recently at just ~2% on an annualized basis.
Inflation Rolling Over
Source: Factset, Fielder Capital Group LLC
Our Misses Hey, we're not perfect. Here’s what we got wrong: We assumed the Fed would pivot sooner. During last summer, we predicted that the Fed would ease up by the fall – just in time for election season – as long as Chairman Powell could point to progress taming inflation. We were wrong. Powell is no Volcker, but he’s shown far more backbone than we gave him credit for earlier. Gold and TIPS were “meh”. For years we have used gold and TIPS (Treasury Inflation Protected Securities) as inflation hedges for most clients. While they performed better than stocks and bonds, neither provided positive returns in 2022. Even though the Consumer Price Index (CPI) leapt higher, longer-term inflation expectations remained low. The Fed convinced markets that it was committed to beating inflation, which lowered demand for inflation hedges. Looking forward, we believe gold and TIPS remain attractive hedges against longer-term inflation (which we believe will likely be higher than markets presume). Aside from these two "macro" misses, there were some "micro" misses. For instance, we were surprised by Bitcoin's decline in the face of inflation's surge. Thankfully, this was a micro issue for most clients. Due to its inherent risk, we had recommended owning no more than a small amount for most clients. Further, Bitcoin remains well above the price when we first recommended it. (Keep in mind: Bitcoin fell ~65% last year, but so did Tesla and Facebook/Meta.) Our Forward View Inflation is not a problem. At least not today. We said that last year, and many disagreed. Recent inflation data continues coming in at a pace below the Fed's earlier expectations. This whiff of good news has been powerful in the face of investor sentiment that is lower today than during even 2008 or COVID. There are some other rays of light: Ukraine is stronger; Putin is weaker. Supply chains are loosening. People are getting back to work – and back to playing. Airports are full. It's no mystery that markets are perking up.
Our forward view is shaped by three themes (or “3 Pillars” as we prefer to think of them):
Debasement. As inflation pressures continue to ease, we expect the Fed to ultimately return to its earlier playbook (repressing interest rates and monetizing US debt in order to fund Washington’s ballooning deficits). Deficit spending is now annualizing at a run-rate of ~ $2.2 trillion, which is ~10% of GDP. This will get even worse if the economy continues slowing and tax receipts fall. The US Treasury will need to issue a lot of bonds to fund its growing deficits. With China, Russia, and Japan stepping away, who’s going to buy our bonds? The Fed, we believe, will be forced to return to its policy of monetizing Washington's debt to fund its growing deficits. The policy objective is to boost asset prices and lower the real value of our government’s debt. Unintended consequences are a risk and will not be smooth for markets.
Infrastructure. After years of under-investment in domestic energy and industrial infrastructure, we observe an inflection point reversing this trend. We believe certain commodities and natural resources will be in short supply as this much-needed investment in new capacity accelerates.
Innovation. While the follies of central bankers make us bearish, the sobering progress of today’s innovators make us net bullish in our long-term outlook. The innovation happening today in biotech, AI, blockchain, and new energy has the potential to create material progress and improvements that could potentially dwarf the boom of last half century. (The above images of 3 Pillars were created using the A.I. of DALL-E.)
All three themes call for owning assets. In the case of Debasement, certain assets are our best defense against inflation. With Infrastructure, we want to own the natural resources we judge most likely in imminent supply shortages as we rebuild critical capacity. And with Innovation, we aim to own a share of tomorrow’s greatest, world-changing companies.
Last year was the worst year of wealth destruction in modern history. None of us enjoyed seeing losses in our portfolios, even if these were just “paper losses”. Nevertheless, we believe Fielder navigated last year comparatively well. We helped clients mitigate losses by balancing portfolios (between playing defense and offense) in ways we judged most prudent. Looking forward, we are enthusiastic about how clients’ portfolios are positioned to benefit from the 3 Pillars of Debasement, Infrastructure, and Innovation.
We are humbled by the confidence our clients have placed in us - especially through such a volatile year. It inspires us to work hard to prove that that confidence is well placed. We wish you all a prosperous 2023 ahead.
Yours in the Field,
Frank Byrd, CFA Steve Korn, CFA
IMPORTANT DISCLAIMER: This note is for educational purposes only. It is not a recommendation to invest in any particular security or strategy, since anything mentioned herein may be completely unsuitable for some investors. Speak with your financial adviser before investing. While the information presented herein is believed to be accurate, Fielder Capital Group LLC (Fielder) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in this email or any attachments. Fielder is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Fielder’s employees are not attorneys or accountants and do not provide legal, tax, or accounting advice. Financial planning and investment strategies have the potential for loss. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Fielder makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Investing involves risk, including the potential of complete loss of principal amount invested. Fielder offers no guarantees or promises of success. Nothing herein should be construed as a recommendation to buy or sell any securities. Fielder or its employees may have an economic interest in securities mentioned herein.
