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Quarterly Letter to Clients 

July, 2022

Indices at quarter-end (June 30, 2022):

    Dow Jones Industrials:             30,775.43       2Q'22            -11.25%           YTD      -15.30%

    Standard & Poor's 500:             3,785.38        2Q'22            -16.45%          YTD       -20.58%


Tough times in the stock market. And in bonds. None of the factors that I mentioned in my last letter have abated: war; inflation; and rising interest rates. Prices continued to trend down.

The war, well, there is not much that we can say or do about that. It will run its course eventually, and as long as it doesn’t spread, it’s effects will ultimately be sorted out. When it does end, markets should get a boost.

Inflation and rising rates will weigh on earnings, and as earnings estimates come down and rates continue to rise, P-E multiples will contract. Translation: stocks are likely to continue going down. As for bonds, as rates have risen, bond prices have fallen commensurately.

Inflation and rising rates are intertwined. In my opinion, it will take a recession to cure inflation. The Fed is caught between a rock and a hard place: they can’t allow inflation to continue, but in order to control it they must cause a recession.

It is very interesting to me that, while we are experiencing inflation (which is a debasing of our currency), the U.S. dollar remains among the strongest currencies in the world. Indeed, only a handful of countries have currencies that are higher against the dollar, and it might surprise you to learn which countries these are: the big ones are Brazil; Mexico; and Russia. Yes, Russia. The ruble is up versus the dollar by over 25% year-to-date. (Think oil, not war.)

Every other major currency in the world is doing worse than the U. S. dollar.

In stocks, the worst of the carnage has been in the high-tech, market-darling names that you see on the financial news every day. From the peak at the beginning of this year to recent lows, Microsoft fell 100 points, almost 30%; Intel is down over 30%; AMD 50%; and Taiwan Semi 40%. Among the market-leading FAANGs, Meta (Facebook) gave back over 50%; Amazon over 40%; Apple is off over 25%; Netflix is down over 70%; and Alphabet (Google) has lost 30%.

These are giant, solid companies with excellent balance sheets and terrific businesses. They just happen to be in the now out-of-favor tech arena.

The damage is worse in second-tier companies. Six months ago I noted that Affirm peaked at 160 and at the then-current price of 100, was still priced out past my likely life span. That stock recently traded at 18. I should have shorted it.

Spotify peaked at 300 and recently was below 100; Okta went from 270 to 83; Snowflake from 400 to 115; and Docusign from 300 to 60. None of these stocks are profitable, and without earnings, where’s the bottom? This is why I don’t buy “fad” stocks. All of a sudden owning some boring, old utilities seems like a pretty good idea.

Not many stocks are up over the past 6 months, and to find them you have to look at some of those staid old cash-generating, dividend-paying, low-P/E companies: Bristol Myers is up almost 25% year-to-date, Merck is up 20%, and Amgen 8%. AT&T is up 15%. And of course, most of the gainers are oil companies, which as a group are uniformly higher: Exxon is up 45%, Shell 20%. Why not, with gas well over $5.00 at the pump?

I hope I am wrong, but I do not think our problems will be solved quickly. Looking at market history we see that, generally, a down year is resolved the next year. In fact, since 1953 there have only been 2 instances of back-to-back losses in the Dow, both in the 1970s; and only one period of three years of consecutive declines, 2000-2001-2002. I consider my viewpoint to be optimistic, that markets will rebound beginning in 2024, meaning that this year and next will not be easy.

I have written letters like this in the past, and I remember the pain then and I feel the pain now. In that 2000-02 period the NASDAQ was down 67%; so far this year it’s only given up 30%. 2002 is 20 years ago, and what’s important is what happened in those ensuing 20 years—stocks tripled, even against todays reduced valuations. You need a long-term perspective to swim in this pond.

Stocks that I have wanted to own for some time appear to be attractive, but every time I nibble I get bitten. I am content to hold cash, even if it is inflating, but as prices drop, I will doubtless nibble some more. I believe that my buys will pay off, but I know that it will take time. Patience is a virtue, and patience in times of pain is very difficult, but might just preserve your wealth.


Jim Pappas

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