Q1 Letter - 2022
In 1310, Mansa Musa was the King of Mali—an empire with an abundance of salt and gold. Commanding these resources made him what is projected to be the highest net worth individual in recorded history. In a massive display of this wealth, Mansa Musa embarked on a legendary Hajj in 1324, marching toward Mecca with 60,000 men, wrapped in brocade or silk robes, carrying 18 tons of gold bricks. In every city he passed through, he showered the poor with gold. During this parade, so much gold was given away in the city of Cairo that it devalued its price by somewhere between 10-25%, sending the city into a rapid inflationary spike which impacted the Egyptian economy for the next 12 years.
Around 700 years later, the United States received similar treatment after a pandemic shutdown led the U.S. government and central bank to shower the American economy with trillions of dollars in fiscal and monetary stimulus, causing inflation to rise to levels not seen since the 1970s. Unfortunately for Cairo in 1310, there was no central bank with the power of interest rates or asset purchase programs to counteract the impact of inflation.
The Fed has already started to tighten financial conditions by increasing interest rates, and has shifted its sentiment on monetary policy from “tactical” to “expeditious”. This comes as the primary measure of inflation, the Consumer Price Index (CPI), increased 8.5% year over year. To tame inflation and bring it back to the long-term goal of 2.0%, the Federal Open Market Committee (FOMC) is now expected to hike interest rates by 50 basis points in May, to a range of 0.75% - 1.0%. The Fed is targeting rates to be between 2.25% - 2.5% by the end of 2022, with some FOMC members calling for even more aggressive increases.
In addition to money supply-driven inflationary pressure, Russia’s attack on Ukraine has significantly disrupted both countries ability to export goods, and coupled with sanctions, there are severe strains on the supply of their most globally prominent exports. The lack of supply of these goods has added to the inflationary pressures already being experienced. Russia produces a notable percent of the world's calories (12% wheat), energy (17% gas, 12% oil), and several precious metals such as palladium (44%), platinum (10%) and nickel (7%) which are used in cars, batteries, and other essential goods. Notably, energy prices feed into food prices. Agriculture is quite energy intensive and natural gas is a key input into fertilizer. In March, Goldman Sachs raised its 2022 Brent spot price forecast to $135 per barrel from $98 as inventories have declined, and its 2023 outlook to $115 from $105.
However, on the bright side, the ability to offset these inflationary pressures by passing along price increases to the consumer has kept the economy in better shape than the stock market indicates. Consumer spending increased 2.7% in Q1 2022. Supply chain pressure has also begun to improve as COVID restrictions ease and the world economy reopens. We are seeing a reduction in material and shipping costs which should help ease some inflationary pressure. There have also been signs of interest rate sensitive items such as used cars finally seeing their prices come down, as higher interest rates have made monthly car payments more expensive, consumers are less willing to pay high prices for these goods.
Additionally, despite the NASDAQ being down ~22% and the S&P 500 being down ~14% through the year (as of 4/29/22), for the most part, corporate earnings and forward guidance have been strong. The most notable exception to this statement is some companies that had benefited uniquely from the COVID lockdowns. Overall, it’s clear that the consumer is still in good shape, which most banks confirmed in their Q1 2022 earnings calls. The banks have great visibility into the health of the consumer because they have data on deposit balances, and credit availability. Bank of America serves approximately 66 million consumer and small business clients and is number one in consumer deposit market share in the U.S. so they are privy to the pulse of the consumer. They shared insightful data on the consumer and noted how healthy they were, and how much more they were spending specifically on travel, entertainment, and restaurants relative to Q1’21. This is important given consumer spending is responsible for roughly ~70% of US GDP. If the consumer is in a healthy financial position, and is still confident enough to be spending more on travel, entertainment, and eating out, then it is mathematically difficult to go into a recession – especially a steep recession where structural economic damage occurs and massive amounts of layoffs result. The unemployment rate is hovering around 3.5%, and there are 1.8 available jobs for every person seeking a job. That means that there are almost twice as many job openings as there are people to fill those jobs.
Brian Moynihan, the CEO of Bank America shared: “Bank of America consumers spent at the highest-ever quarter one level, which is a double-digit percentage increase over Q1 2021, unemployment is low and wages are rising. Company earnings are also generally strong. Credit is widely available. And our customers' usage of their lines of credit is still low, i.e., they have capacity to borrow more. The average card balance of our credit card customers that had deposit relationships are still 8% lower than they were pre-pandemic. They continue to pay down their balances on a monthly basis at a higher rate than pre-pandemic. And as you know, delinquency rates are significantly lower. Industry data points around debt service levels are hovering near historic lows and household deposit and cash levels are $3 trillion higher than we entered the crisis.”
We believe that when markets get choppy, there is no better time for active management as we increase our selectivity in allocations to quality assets that have the ability to grow through the turmoil we’re experiencing. Our dedicated research team and Investment Committee continue to stay on top of markets with an information edge. As always, we appreciate the trust you’ve placed in us to manage your capital. If you have any questions, feel free to reach out.
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