Wednesday, January 11, 2023

“The stock market is a device to transfer money from the impatient to the patient.” – Warren Buffett

From the Desk of Joe Rollins

I guess it could be said that I really missed the mark on my 2022 stock market prediction. When you looked at all the data and financial activity, it was pretty clear to me and most analysts that the market would be up in 2022. The analysts and I just assumed that we would have normal economic activity in 2022, which would lead to higher prices later. I guess Casey Stengel said it best, “Never make predictions, especially about the future.”

I forecasted the year-end for 2022 at roughly 5,200. The actual ending number was 3839.5. As you can see, there is quite a gap between my prediction and reality. However, many people were on the same wavelength as me. As an example, Merrill Lynch forecasted 4600, Barclays forecasted 4800, Citi Bank forecasted 4900, Credit Suisse forecasted 5200, and Oppenheimer forecasted 5330. I guess we were all taken by surprise by the economy and stock market’s performance.

I have many subjects that I want to talk about in this posting, including things that people probably have not read about or fully understand. However, virtually all of them are positive with respect to the economy. I have interesting thoughts on the disruptive natural gas supply in Europe, oil prices in the United States in the coming years, the revolution in building microchips in America, and why all the so-called layoffs of employees is actually not the bad news the media would like you to think.

Pals Judge Jerry Baxter and Liz Mercure out for a hike in NC
We are in a period of time where good news is bad news, and bad news is good news. I know that the average observer of the stock market does not understand that mentality, but that is where we are today. Any good news whatsoever makes the market go down since that would presume that interest rates would be higher and, therefore, negative for stocks. Only when you have bad news does the market go up. I know it does not seem logical, but that is the mentality on Wall Street today.

Before I get into those terribly interesting topics, I need to report on the absolute bloodbath that was the financial markets in 2022. I was looking at the list of approximately 150 separate mutual funds at Fidelity. Of those 150 funds, less than 10 had positive returns in 2022 and virtually all of those were oil stocks or oil-related securities. Even the more conservative bond funds lost money in 2022 and the so-called famous 60/40 portfolio mix lost 16.1% for the year. That means if you had a portfolio during 2022 that was represented by 60% bonds and 40% stock funds, you would have lost 16% as compared to the S&P which lost 18.1%. There was truly nowhere to hide during 2022.

The Schultz Family
It’s not what’s under the Christmas tree that matters,
it’s who is around it.
The Standard and Poor’s 500 Index was down 18.1% during the year, but the good news is that it was up 7.6% during the final quarter of 2022. The NASDAQ Composite was even worse as it was down 32.5% for the year 2022 and 0.8% for the last quarter of the year. The Dow Jones Industrial Average was down 6.9% for the year 2022 but was up nicely 16% in the final quarter. Just for a basis of comparison, the Bloomberg Barclays Aggregate bond index was down 13% in 2022 and up 1.7% during the final quarter of 2022.

Although the numbers above were truly bad, you have to realize that this was the first significant loss year of the S&P 500 since 2008. We have enjoyed 14 years of excellent growth in the above indexes. Even with these large losses in 2022 the 10-year average on these indexes is still quite excellent. The 10-year average return on the S&P 500 is 12.6%, the NASDAQ Composite is 14.5%, and the Dow Jones Industrial Average is 12.3%. Even with the huge losses in 2022 year, these three indexes have annual gains in the double digits for the last 10 years.

Ava and CiCi taking turns opening presents
There are a great many things that happened in 2022 that were clearly unexpected which affected the market. One of the first things that happened was the Russian invasion of Ukraine which caused the price of oil to go up to roughly $125 a barrel in March. Given that the price of a barrel of oil today is roughly $72, you can see the dramatic change that has occurred in that inflation-rich factor. I guess we can all thank President Putin for that price increase. I had originally thought that the Russian/Ukraine War would be swift to complete but due to the heroic efforts of the Ukrainian military, they have done substantial damage to the Russian army and have provided a favor to all western countries in demilitarizing the Russian army.

After ten months of military conflict, it appears to be a stalemate or maybe Ukraine has somewhat of an advantage. But the longer the war goes on, the clarity is that Russia does not have the military capability to attack a NATO-bordering country. Back when the war broke out in February of 2022, historical forecasters were predicting that Russia would take Ukraine and then attack Poland. As I wrote in these pages, that assertion was ridiculous, given that NATO has roughly ten times the number of soldiers that Russia maintains.

Cameron visiting a newcomer in isolation at the
Tacugama Chimpanzee Sanctuary in Sierra Leone
We were also surprised by China’s heavy-handed Covid-19 crackdown. For much of the year 2022, China was going around shutting down factories and cities over even minute Covid-19 cases. By the end of the year they had abandoned that, but the result is that China is roughly two years behind the United States in spreading group immunity. During the year 2022, these massive crackdowns led to supply chain issues which slowed down the economy in the United States and certainly hurt shipments coming out of Asia. However, as we sit here today, the supply chain has caught up and now you are seeing not only reasonable prices but reasonable delivery dates on products coming out of China to the U.S.

However, the most disruptive news during 2022 was that the Federal Reserve hiked interest rates by 4.25% in just nine months. It has been rare in American finance history that interest rates have been driven up by the Federal Reserve so quickly over such a short period of time. The enormous volatility in the financial markets was a result of these huge increases. Of course, the real reason for these increases was to slow down the economy and create a period of time where inflation could actually catch up to the Federal Reserve’s goal of 2% annually.

The year 2022 will also be looked at under the spectrum of the Federal Reserve trying to slow the economy while the Federal Government was flooding the economy with money. We had the unusual situation where the U.S. Government continued to provide funding for numerous programs, thus funding the U.S. economy and inflation as the Federal Reserve was attempting to slow down the economy and inflation. You would think they would have at least attempted to work together to slow it down in concert.

Bundle of Joy
Client Mike Battle bonding with his first grandchild
Did you realize that during the year 2022, there was an increase in employment every single month in the U.S. economy? The U.S. economy added 4.5 million jobs and there was not a single month that there was a decrease in jobs. The year 2022 was the second-best year for job creation since 1940. If you recall, 1940 was the year preceding the ramp-up of the U.S. economy for WWII. The first was in the Covid-19 year of 2020.

So, was the Federal Reserve successful in slowing the economy during 2022? At the beginning of the year, the unemployment rate was 3.9% and at the end of 2022, the unemployment rate was 3.5%. As you can see, contrary to the desire of the Federal Reserve, as the year progressed, the economy actually got better. You may recall that there was much handwringing in the first two quarters of 2022 by the so-called experts that we would clearly have recession in 2022. What was interesting is that the GDP in the United States actually rose higher as the year went along. In the first quarter GDP was -1.6% and in the second quarter of 2022, GDP was -0.6%. Virtually to everyone’s surprise during the third quarter of 2022, the GDP bounced higher to 3.2%. The Atlanta Federal Reserve is forecasting that the GDP for the fourth quarter of 2022 will be an outstanding 3.8%. In fact, if the forecasters are correct in that assumption, rather than the U.S. economy falling into recession, it will have actually increased in GDP as the year went along.

Caroline + Reid
“May you never be too grown up to search the skies on Christmas Eve.”
While certainly, it is not easy to forecast 2023, it is satisfying that the Federal Reserve itself is not forecasting recession. While clearly there may be a slowdown, I too do not believe that we will fall into recession in 2023 since there are just too many positive economic events going on for that recession to come true. Just for the record and for those that ask me often about job openings, as of late November, there are 10,458,000 job openings and only 5,722,000 unemployed Americans.

One of the great mysteries that we will look back on in 2022, is why on earth do we have twice as many job openings as we have unemployed people. The unemployment rate today at 3.5% is one of the lowest unemployed percentages ever in the history of American finance. To this very day, employers are struggling to hire any employees whatsoever. It is just hard to conceive that recession could be coming in the near future given the absolute strength of employment in the United States.

We heard so many projections in 2022 that have failed to be realized. One of the projections was that due to Russia turning off the oil and gas supplies to Europe, the entire continent would suffer frigid winter months. Here we are halfway through winter already, and Europe has announced that they have solved their natural gas issue and have adequate natural gas to heat Europe through the winter. All that was required was for the U.S. and other countries to provide Europe with liquified natural gas which they could store in the summertime and have available for winter. It was announced over the weekend that Germany’s natural gas storage is above a 90% level. So much for the dire predictions that Germany would freeze during the winter months.

Catch anything?
Ziming Yu and a friend checking out the
Georgia Aquarium over the holidays
One of the main reasons why the economy has been so strong during 2022 is the generous funding of numerous plans by the federal government despite no tax revenue to cover those expenditures. In fact, the government wanted to spend a whole lot more money, but due to the split in congress they were not able to fund the various welfare plans that they had hoped to. Unfortunately, while it is not a problem today, it will be a problem in the future due to the deficits in the economy exploding during 2022.

Virtually all the money spent for these favored programs was deficit money with no specific revenues to cover them. Due to the stock market doing so poor in 2022, there will not be any capital gains revenue to offset these deficits. In 2021, the treasury generated almost a trillion dollars in capital gains taxes. In 2022, it is highly likely that it will generate none.

"Grandchildren are the dots that connect the lines
from generation to generation." — Lois Wyse
Harper and Lucy got to spend time with
both grandmothers over Christmas
I could write a whole posting on deficit spending and how it helps the economy and whether there really is a problem creating deficits. At the end of the day, deficits are not a real problem. Any time you have the ability to print your own money and the money is not guaranteed by any asset, and as long as there is a willing partner who will accept that printed money, deficits are not an issue. However, in recent years the federal government has gone crazy and has run up our national debt close to $30 trillion. The interest on that debt alone will become more challenging as we go forward. Once again not a problem for today, but certainly a problem for the future.

It is very interesting that in 2022 the automobile industry in particular was held back by the fact that they could not get microchips for their cars. What was so confusing to many investors is that every chip manufacturer was sold out and could produce no more chips for the next year yet their stocks were all down 50%. Much of the automobile manufacturing in the United States was held up for lack of these chips. Only recently have chip deliveries started to catch up for the auto industry.

However, there is really good news on this subject. Due to the money given to chip manufacturers by the U.S., they are building huge manufacturing plants in the United States. Intel Corp. is building a huge facility in Ohio and Taiwan Semiconductors Manufacturing Co. Ltd. is building a comparable plant in Arizona. If ever we had a national defense problem, it would be in chip manufacturing. If in a time of war we were cut off from chip manufacturers in Asia, we would be virtually handcuffed from building military armaments. The fact that we are building these plants in the United States at the current time is extraordinarily bullish for the future of America.

Ava and Joe watching the game. I wonder who Ava was cheering for?
Almost everyday you read some article in the financial press about big tech companies laying off employees. When Amazon announced that they were laying off 18,000 employees, it was the leading headline all day long. They rolled out a number of so-called “experts” to explain how serious the financial situation was with Amazon in that they had to layoff 18,000 office workers.

Obviously, people who get hysterical regarding that information do not bother to look at the facts. Yes, there are layoffs occurring in beg tech at the current time, but there needs to be. Just to give you an example of the growth in that sector, look at the actual number of employees, both pre-Covid and post. In 2019 Amazon had 798,000 employees, in the third quarter of 2022 they had 1,544,000 employees. Therefore, when they announced that they were laying off 18,000 employees, it was just a little over 1% of their employee base.

The same can be said for virtually all of tech. Alphabet Inc. had 118,899 employees in 2019 and 186,779 employees in 2022. Meta Platforms which is the old Facebook had 44,942 employees in 2019 and in the third quarter of 2022 they had 87,314 employees. As you can see, virtually all of these have grown their employee base over the last couple of years by 100%. It would be irresponsible for them not to consider layoffs at the current time given their bloated employee situation at work.

Happy Pawlidays from CiCi
Another thing that has come up lately is that the productivity of workers has fallen in the United States. This is the first year in many where productivity has actually inched down. Many experts believe that is due to the work-from-home concept, but I think it has more to do with the fact that we have too many employees trying to do the job. Down through time we have found that if an employee is not pushed to produce, productivity fades away. I rather suspect that is the real reason in the fall of productivity, rather than the work-from-home concept.

A few people realize the effect of currencies in corporate earnings. When the United States started increasing interest rates in March of 2022, that made the U.S. more attractive to foreign currencies. As people rushed to move money to the United States, it forced the value of the dollar up. A higher dollar is actually a negative for corporate earnings. That makes U.S. based products more expensive internationally and makes international products less expensive here in the United States. During the second and third quarters of 2022, this huge increase in the dollar dramatically reduced earnings of U.S. corporations.

During the fourth quarter of 2022, foreign central banks caught up with the trend and started to increase their interest rates which forced the value of the dollar down. The dollar has fallen dramaticlly over the last several weeks and months and now should be a net positive for corporate America. This fact alone should increase earning in 2023 as a net positive as compared to the net negative that it was in 2022. I know these points are technical in nature, but they are very meaningful to understanding corporate profits in international commerce.

Cecilia Cmeyla and her Aunt Brisa over the holidays,
leaving no doubt that they’re related
So, I would like to give you some predictions you can hold me accountable to this time next year. It is interesting what is going on in the oil industry. As I mentioned above, the price of oil has gone from $125 a barrel down to roughly $72 a barrel at the current time. What you do not realize is that rotary drilling operating in the United States is up almost 32% over the last year. This time last year, there were 727 rigs working and now there are 961. It seems that the oil industry has caught on to the higher prices and is beginning to produce at a higher level. I think what will happen is what has happened so often in the past. Due to a shortage of oil in the United States, we are working our way back to a glut of oil here at home. This is a very good thing.

It has taken roughly two years to overcome the restrictions on drilling oil that the new President installed. I personally believe it was his clear desire to get the oil prices up, and by restricting their permitting he was able to accomplish that. A great deal of that help can be attributed to Putin beginning a war that nobody wanted in Ukraine. But all of a sudden American oil is gearing up for higher production.

It is my projection that before the next President is installed in office, the U.S. will once again be energy independent. We reached energy independence during the Trump Administration but due to the restrictions on new drilling, we lost that advantage several years later. If oil production in the U.S. continues at the current level, we will not care about the price of oil produced in the Middle East or Russia.

The economic effects of the war in Ukraine and the sanctions on Russia are crushing the Russian economy. I would hate to think of the pressure that the Russian government is undergoing now due to the bad news coming out of Ukraine. The one aspect of any war that affects people’s feelings is the reality that sets in when they send back deceased soldiers to their families. When you have a death of a son or daughter, a brother or sister, or a father or mother, it has a huge emotional impact on a country.

Evan Bentley and Alexis Chambers under the lights
at Truist Park for Evan’s company party
Even though they are not allowed to express their outrage in Russia, it is clear that the population is beginning to suffer due to this war that no one wants or really needs. The Ukrainians have done the U.S. a great favor in demilitarizing the Russian government and therefore will reduce the cost of building military armaments for decades to come. It is also clear that a winding down of the Ukrainian war will have to occur due to depleted military supplies by both sides.

From an economic standpoint, inflation is starting to fall and the November numbers were very encouraging. November was the fifth consecutive month of declines suggesting that inflation has clearly peaked. The next big number that all of us we will have to watch out for is what corporate earnings are going to do with the upcoming projected recession. During the fourth quarter of 2022, it was thought that corporate earnings would be up 5.1%. So if corporate profits are higher in the fourth quarter 2022, what will they project in 2023 based upon the so-called upcoming recession?

This gets us into the meat of the question as to what we expect in 2023. Based on my reading of the economic tea leaves, I do not think we will have recession in 2023. We might have a slowdown, but definitely not recession. One of the beauties of investing is that the stock market projects far before the economy bottoms. Most people believe that the stock market will rally six to eight months prior to the economy bottoming out. Based on this information it would seem that the first half of 2023 should be rocky and volatility will continue to capture the market. It looks to me like the second half of 2023 should be excellent in almost every respect.

Finally, now stock prices are at a level that seems to be more than reasonable. At the current time, the S&P P/E ratio of 19.1 is well in line with the long-term averages. Over time this index has averaged a P/E ratio of 19.8. In late 2020 that same ratio was 30 times earnings. So, the correction in 2022 dramatically reduced the fair value of the stock market.

Fake it till you make it!
Elizabeth Flores’ dog, Rico, convincing Santa to add him to the “Nice List”
We are seeing inflation fall fairly dramatically and even by the Federal Reserve’s projection, inflation at the end of 2023 should be at 3.5%. All the economic forecasters that I review indicate that we are very close to a bottom and the fact that the fourth quarter of 2022 yielded positive financial results should indicate that 2023 should be quite satisfactory.

Based on that information, I forecast that we should see gains in the financial markets in 2023 of roughly 20%. While that amount will not completely recover the losses of 2022, it will build a strong foundation for many profits in the future.

If you have an interest in coming down to visit with us, we look forward to seeing you. We are moving into tax season for our Firm and will have the time to sit down and review your portfolio, taxes, or anything else you might be interested in.

As always, the foregoing includes my opinions, assumptions, and forecasts. It is perfectly possible that I am wrong.

Best Regards,
Joe Rollins

All investments carry a risk of loss, including the possible loss of principal.  There is no assurance that any investment will be profitable.

This commentary contains forward-looking statements, which are provided to allow clients and potential clients the opportunity to understand our beliefs and opinions in respect of the future.  These statements are not guarantees, and undue reliance should not be placed on them.  Forward-looking statements necessarily involve known and unknown risks and uncertainties, which may cause actual results in future periods to differ materially from our expectations.  There can be no assurance that forward-looking statements will prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements.