Q4 Letter - 2022
“It’s only when the tide goes out that you learn who has been swimming naked”
― Warren Buffett
There’s no sugar-coating it, 2022 was a historically difficult year to navigate in the financial markets. It was the worst year since the Great Depression for a conservative 60% stock / 40% bond portfolio. The year began with equities tumbling due to fear around the resurgence of COVID via the Omicron variant. In February, Russia’s invasion of Ukraine strained global supply chains even more than they already were and introduced a new level of fear and uncertainty in global markets. In March, the Fed begrudgingly admitted inflation may not be “transitory” and made its first move to raise interest rates, taking the fed funds rate from 0.25% to 4.25% - 4.5% over the course of the year. The impact these moves had on asset prices cannot be understated.
Nowhere to Hide
The inverse relationship between interest rates (rising) and bond prices (falling) led to record declines in bond values. The benchmark U.S. government bond index was down more than 15% in 2022, making it the worst year ever for “risk-free” bonds. Large-cap companies fared better than smaller companies initially, but were not spared from multiple contraction, as the S&P 500 closed down more than 19% by year-end.
The equities most impacted by the Fed’s record speed of rate hikes were tech companies that were growing quickly as remote work accelerated the adoption of many software platforms and technologies. Many of these companies over-hired as they anticipated this newfound demand to resume, and they were in a race to grab market share as quickly as possible before their competitors could. Investors that were funding this “growth-at-all-costs” had expected these companies to reach a certain level of scale where they would become profitable. Now that the COVID tailwinds have died down, these companies that poorly forecasted demand (which led to inefficient capital allocation) have been punished by Wall Street.
Additionally, investors now have alternatives in fixed income that provide more attractive returns in the form of cash flow today, and thus are less likely to be willing to wait for tech companies to eventually become mature and profitable, thereby capable of providing returns in the form of dividends and stock buybacks. With future earnings now discounted at more than 0%, tech companies that had their valuations based on hope, and revenue multiples, not earnings multiples, had the furthest to fall.
What Comes Next?
However, all that matters now is what happens from here, not what happened in the past. Over the course of 2022, S&P 500 earnings per share estimates for 2023 have been revised down almost 10%, from $252/share to $228. Many are calling for further cuts to this 2023 earnings forecast, however, that doesn’t necessarily mean that all stocks will go down. Not all will bottom at the same time. There is wide dispersion in expectations for companies, some are currently already priced for significant pain already, while some still have too rosy of a picture painted. Times like this favor our strategy of more active investment and risk management.
Since 1970, earnings have declined on a yearly basis 17 times and in 12 of those instances, the S&P 500 was up. In that period, 1975 was the second-best performing year for the S&P 500 (+32%), yet earnings declined 11%. 1994 saw the fourth largest increase in earnings (+40%), but the S&P fell 2% that year.
Over very long periods earnings are important, but in the short-term earnings are not as important as most believe.
The labor market softened slightly towards the end of 2022. The number of available jobs dropped relative to the unemployed illustrating a shift in the labor market equilibrium. However, real wage growth, albeit negative, is still growing. The U.S. unemployment rate is 3.7% and the expected unemployment rate for the end of 2023 is 4.4%. Both are still far below the 10-year average unemployment rate of 5.3%. Interestingly, signs of household balance sheet stress at the beginning of the rate cycle have proven more resilient than would have been expected in the beginning of the year.
The most important factor in the financial markets continues to be the Fed’s action to combat inflation. We have now seen multiple consecutive months of slowing inflation, with raw materials prices (input costs) normalizing.
Demand destruction has seemingly been effective thus far with the supply-side constraints unwinding in 2022. As of December 31, 2022, zero shipping vessels were waiting off the Los Angeles port, compared to a record backlog of over 100 ships a year ago. The price of shipping containers from East Asia to North America fell from their 2022 highs around $16,500 to $1,400 today.
Looking into 2023, the Fed will continue to grapple with a difficult policy setting environment. Unemployment remains historically low, and the U.S. consumer has been more resilient than many feared, giving the Fed more latitude to keep rates in a restrictive range, if they need to. However, on the other side of this phenomena, if the unemployment rate begins to march higher, the Fed now has room to cut the fed funds rate back to a more normal long-term range of ~2.5% - 3.0%, which would be extremely positive for financial markets.
Differentiation Mattters
Despite the turbulence in 2022 we are pleased to report that in 2022, our strategies outperformed their benchmarks. Our team worked diligently to carefully select securities with strong and resistant fundamentals, while also placing a strong emphasis on managing risk appropriately, ensuring that our clients' assets were more protected even in times of market volatility.
Some are anticipating Armageddon, while some are anticipating a premature shift in the hawkish Fed narrative as inflation appears to have peaked in Summer 2022. We believe that the appropriate positioning is somewhere in the middle, and it’s prudent to manage risk in this higher cost of capital environment until there are more clear signs that the Fed will stop raising rates, but also be selective in allocating to companies with strong fundamentals that have been overly discounted and will remain more resilient than expected.
We are grateful for the trust that you have placed in us, and we look forward to continuing to serve as your partner in achieving your financial goals. If you have any questions or concerns, please do not hesitate to contact us.
Information presented reflects the personal opinions, viewpoints and analyses of the employees of Mirador Capital Partners, LP, an SEC-registered Investment Adviser. The views reflected in the commentary are subject to change at any time without notice. Nothing herein constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Mirador Capital Partners, LP manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results. Visit us at miradorcp.com for more information.