A Lightning Round on Markets

March 21, 2022

Much has transpired since our late February update when Russia’s invasion of Ukraine commenced. Interestingly, however, markets are now higher than they were at the timing of that update. All told, the S&P 500® Index is down 6.1% year-to-date, by no means a disaster given the headlines we’ve witnessed (although many stocks are down much more). There are a number of hot topics on investors’ minds. We thought we’d take a moment to address some of the issues:

  • Russia/Ukraine/Oil: The ongoing conflict is deeply troublesome on many levels, most notably the human toll. Another consequence of the situation has been a spike in oil prices and many other commodities (Russia is the world’s second largest producer of oil). In fact, the price for extracted resources, as a percentage of gross domestic product (GDP), is at a 50-year high according to Bernstein. This is prompting a variety of pressures ranging from higher prices at the pump to higher input costs for companies. While good for commodity producers, higher prices could squeeze consumers’ pocketbooks (maybe offsetting “re-opening” demand), crimp corporate margins and generally help promote an economic slowdown.
  • Federal Reserve/Monetary Policy: Partly as a consequence of spiking commodity prices, inflation levels are elevated (the consumer price index advanced 7.9% in February…a 40-year high) and the Fed is committed to tighter monetary policy to ensure inflation doesn’t spiral out of control. It just raised interest rates for the first time since 2018 and remains intent on 7 rate hikes this year. True, the emergency stimulus post pandemic is no longer needed and inflation does need to be constrained, but many fear excessive tightening could also prompt a slowdown.
  • Stagflation: In turn, we’ve seen fear of stagflation increase. Put simply, stagflation is the dreaded scenario of elevated inflation alongside no/low economic growth. This becomes more likely if rising commodity prices are primarily a supply driven phenomenon (i.e. a byproduct of war, lower production and supply chain issues) and Fed efforts to tighten policy simply crimp economic activity while doing little to address underlying inflation sources.  Economists continue to forecast decent GDP growth for this year and next, thereby implying that most do not anticipate Fed policy will trigger recession. But, the risk has risen.
  • Pricing Power: What would an investor do in this type of environment? Naturally, many think of owning commodities or commodity producers in such an environment. We also note that pricing power, while always a focal point for us, becomes even more important. Whether dealing with inflation or stagflation, a company’s ability to raise prices is paramount.  A company should be able to grow earnings and dividends at a rate at least commensurate with inflation if it has a resilient business and can raise prices to offset higher input costs (wages, materials etc.).
  • International Investing: Russia’s invasion of Ukraine has cast a new light on international investing. While Russia represents only 1% of revenue for the S&P 500, the conflict has caused some investors to re-think their exposure to foreign markets. Maybe in the long term the current conflict will promote leadership change and help integrate the likes of Russia, but in the near-to-intermediate term we seem to be going through a process of de-globalization. In addition to government sanctions, many corporations have shut down activities in Russia. This corporate warfare seems warranted, but could become a slippery slope. What if some companies decide to do less business with China (a huge source of demand for many companies) given ideological differences? We acknowledge that many international/emerging markets remain attractively valued, but are being more diligent about our exposure. Some actually look more appealing as their export activity may benefit from export shortages from both Russia and Ukraine.
  • Growth vs. Value: For much of 2021, we argued many “growth” stocks were overvalued. Many hot names, particularly in the technology arena, were benefitting from cheap money and momentum. Meanwhile, many “value” stocks, including energy and financial stocks, seemed too cheap. So far in 2022, the pendulum has swung significantly, with value stocks outperforming growth by a wide margin. While many high-fliers have been defrocked, the market now appears more balanced and a number of higher growth situations are now trading at much more reasonable valuations.
  • Valuations: The P/E for the S&P 500 has come down roughly 2 points year-to-date and valuations look more reasonable than they did at the start of the year. Risk is higher so this makes sense. We still find ourselves expecting more moderate returns. While a quick resolution in Ukraine could prompt a relief rally, rising interest rates and tighter monetary/fiscal policy will remain a headwind. That said, we’ve started to uncover more value among individual names and have added to stocks recently. In other words, we may feel a bit queasy about the overall stock market, but we like a bunch of stocks.

Important Disclosures:

Past performance is not indicative of future results. Diversification and asset allocation does not ensure a profit or guarantee protection against a loss. There is no guarantee that a company will continue to pay dividends. The statements and opinions expressed in this article are those of Davenport Asset Management as of the date of the article, are subject to rapid change as economic and market conditions dictate, and do not necessarily represent the views of Davenport & Company LLC. This article does not constitute investment advice, is not predictive of future performance, and should not be construed as an offer to sell or a solicitation to buy any security or make an offer where otherwise unlawful. Investing in securities carries risk including the possible loss of principal. Individual circumstances vary.

Important Definitions: The S&P 500 Index is comprised of 500 U.S. stocks and is an indicator of the performance of the overall U.S. stock market. Standard & Poor’s Financial Services LLC, a division of S&P Global, is the source and owner of the registered trademarks related to the S&P 500 Index.