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Quarterly Letter to Clients

January, 2023

Indices at quarter-end (December 31, 2022):

Dow Jones Industrials: 33,147.25 4Q'22 15.39% YTD -8.77%

Standard & Poor's 500: 3,839.50 4Q'22 7.08% YTD -19.44%

A rising market gives us confidence; a falling market takes away that confidence, and makes us question every decision. There is a term, "relative performance," meaning how you have fared compared to the broad market indices. If the market is down 25% and you are down "only" 20%, you (theoretically) can boast that you "beat" the market by 5 percentage points.

Small comfort.

We recall the phrase, "you can't eat relative performance." Or pay your mortgage with it.

In the fourth quarter stocks rebounded some, finishing the year well off the low touched in early October, but still down sharply for the year.

The various averages diverged significantly this year. Tech stocks, long market darlings, were shunned in favor of stodgy names. The old-line Dow Industrials gave up almost 9%, while the tech-heavy S&P lost over 19% and the yet-more-speculative NASDAQ tumbled more than 33%. Relatively speaking, the Dow was the star in 2022. Yeah, thanks. Take a bow, Dow.

It seems to be gradually dawning on the investing community that the Fed will not stop raising rates until such time as inflation is under control, and that happy circumstance does not appear to be in the immediate future. The effect on housing specifically has been severe, with mortgage rates doubling, and housing starts tumbling. We see first hand the effect on stocks and bonds.

There is, though, a little breathing room as far as fixed income, with the 6-month T-bill now yielding nicely over 4.5%, up from basically zero not all that long ago.

While supply-chain issues have abated, easing cost pressure, the inflationary force that really needs to be overcome now is wages, which have moved higher amid a strong labor market. The decline in housing and large layoffs in the tech sector should help on that front, but have not yet appeared to do so, and the demand for, and price of labor have moderated only slightly.

In the last two decades the market has generally risen, while interest rates in general declined. Only 2008 and 2022 showed any painful fall, and there were no back-to-back annual declines in stocks. We have become used to buying any dips, believing that to be a wise strategy. It was not that simple this past year. Rates began to rise and stocks reacted appropriately. One needed to be very critical of the price of any enterprise under consideration, and still it was a treacherous time to invest.

Of course, if the war between Russia and the Ukraine were to find an end, markets would rocket higher. There are always wild cards that can dramatically affect markets.

Perhaps we (meaning the investment community in general) have grown complacent, and perhaps less defensive in our security selection. I have been in this industry for 56 years now, and I have to go back to the beginning of that tenure to recall another period when bonds and stocks fell in tandem, and this much. Even a sharp eye on balance sheets and a fondness for dividends has not insulated me. Because I invest personally the same way that I invest for my clients, I feel the same pain that you do.

Higher rates and higher labor costs seem likely to depress earnings for at least most of the new year. It is my hope that we have only a shallow recession, and can begin to work out of it before year's end, with inflation under control, and without too much damage to the economy. I now believe that this is a reasonable supposition. It is likely to be a challenging year, but I expect that we will begin to see the light at the end of the tunnel before it is over.

I wish you happiness and health in the New Year.

Jim Pappas