July 5, 2022
The past six months have been challenging, and we know you may be feeling the stress of watching from the sidelines as global markets tumble and your hard-earned savings fall in value. LongView’s portfolios were not immune to the general downturn, and we shared some of the tribulations of other sustainable investors. However, several tactical steps we took earlier last year have helped soften the impact. We hope the following observations will put things into a broader perspective and boost your confidence as we ride through the storm, knowing that brighter days lie ahead.
For those of us who had hoped that the waning of the COVID pandemic would bring relief from the social and economic disruptions of the past two years, the first half of 2022 has been anything but gratifying. Runaway inflation, the war in Ukraine, soaring interest rates, a global energy shock, worsening geopolitical tensions, and a slowdown in economic growth have taken a heavy toll.
The S&P 500 endured its worst first-half year since 1970, and the bond market fell more than at any time since 1842. With gas prices and mortgage rates doubling, and costs for food, energy, and transportation all sharply higher, the pain has spread quickly from Wall Street to Main Street.
While such a decline was not entirely surprising for equity investors accustomed to volatility, bond owners were shell-shocked by declines of as much as -25% in an asset class normally prized for its low-risk characteristics.
The only sectors posting gains in the first half were energy and defense stocks. Meanwhile, technology, as well as growth stocks in general, suffered heavy losses. This environment has proved challenging for socially responsible investors, who typically avoid fossil fuels and weapons while overweighting tech. Many sustainable funds have significantly lagged the market this year as a result.
As mentioned above, some of the pre-emptive moves that we made prior to this year have helped mitigate the effects of the downturn on our portfolios.
On the equity side, our 10% allocation to J.P. Morgan’s Hedged Equity funds (US and international) which use an option strategy to limit downside risk, provided a welcome buffer, declining by half as much as the broad market. In addition, value stocks have outperformed growth stocks by the widest margin in years. Our investment last year in the Nuveen ESG Large Cap Value fund, which we made with the express purpose of temporarily overweighting value in our portfolios, allowed us to benefit from the sector’s relative outperformance.
On the capital preservation side, the lower-than-average maturity of our bond funds, which we have maintained for the past several years due to our concerns about rising interest rates, helped cushion our fixed income holdings from the worst losses of the bond market. In addition, we dialed up our allocation to Alternative Strategy funds, which we use as less inflation-sensitive alternatives to traditional bond funds, and which did an excellent job of limiting downside despite this year’s staggering spike in interest rates.
The opportunity to rebalance portfolios and harvest tax losses is one of the silver linings of bear markets. We are making the most of this, realizing losses that our clients can carry forward to offset future gains while making sure to keep portfolios in line with their long-term asset allocation targets.
Even with these moves, it's been a tough year, and we don’t think we are out of the woods yet. Inflation will not disappear overnight and we expect the Fed to continue raising interest rates in the coming months. The Ukraine war will pressure supply chains and exacerbate shortages until a resolution is reached. Early signs of economic weakness (falling mortgage applications, slowing home sales, swelling retail inventories, declining freight rates) are starting to emerge. Needless to say, political uncertainty in the US will only increase as we approach the November midterms.
Higher interest rates affect the economy in various ways. By making borrowing more expensive, rising rates suppress consumer spending. The higher cost of capital puts pressure on corporate profit margins, in turn slowing investment and hiring. In addition, higher rates directly impact financial assets, putting downward pressure on the valuations of both stocks and bonds. If the rise in rates is sustained, the combined effect on consumer demand, corporate earnings, employment, and asset values, can eventually lead to recession. The Federal Reserve's current campaign to throttle inflation with higher rates therefore poses a real threat to growth and profitability.
However, the repricing of financial markets to adjust to the challenges of the past six months is running its course. A lot of bad news regarding interest rates, inflation, and the risk of recession is already reflected in asset prices.
The bear market in stocks and bonds has brought prices down to levels that are beginning to attract the interest of long-term investors. For the first time in years, bond buyers can enjoy yields of anywhere from 3% on short-term government securities to 5% on investment grade corporate bonds, and 8% on high-yield (aka “junk”) bonds. Equity investors are looking at prices that are on average 20% lower than just six months ago, with certain formerly leading sectors (e.g., tech) down 30%-40%. The market “froth” exemplified by crypto-currencies, meme stocks, SPACS, and high-flying but zero-earning start-ups, has been thoroughly expunged, with losses of 75% or more in a wide range of speculative investments.
The current outlook is also brightened by a still-tight labor market, ongoing wage gains, and the lingering effects of pandemic stimulus, which put cash in people’s pockets and enabled companies to refinance their debt at ultra-low interest rates. As a result, both consumers and corporations are in a stronger than usual position to face more challenging conditions.
2022 so far has presented the most challenging environment since the financial crisis of 2007-2009, and markets could fall further from here. Nevertheless, we believe the coming year will offer a host of opportunities for investors who aren’t derailed by volatility and who remain committed to their long-term investment plans.
The Controversy about “Greenwashing” in ESG Investing
You may have been following the recent media storm surrounding ESG investing, the legal investigations of certain fund companies’ claims around the impact of their investments, and the current attack on sustainable investing approaches in general by right wing politicians. We will be writing more about this in the coming months, but for now we want to convey to you that we believe the sustainable investment movement will only be strengthened by more rigorous definitions and disclosures.
We have been practicing a responsible investment philosophy for years, we know our funds well, and choose them carefully. We are not afraid of questions about “greenwashing” and we enjoy discussing our multi-pronged approach to sustainable investing. LongView is a fiduciary and we abide by a dual mandate of helping our clients reach their financial goals while aligning their investments with their values.
As a final aside, we were proud and delighted to be awarded with the Historic Santa Fe Foundation’s 2022 Architectural Stewardship Award for our restoration of Hovey House as LongView’s new downtown office (see our blog post of July 1.) If you have not had the opportunity to come visit us here, we warmly invite you to do so.
With our best wishes for a beautiful summer, peace, and good health.