Mr. Market Strikes Back
Telemus Weekly Market Review May 2nd - May 6th, 2022
In his 1987 annual letter for Berkshire Hathaway, Warren Buffett talks about Benjamin Graham, the father of value investing, describing an imaginary figure Mr. Market. Mr. Market was an unfortunate individual with incurable emotional problems where at times he feels euphoric and at others depressed¹. The price he is willing to offer for shares of stock depends on his feeling that day. This past week served as a reminder that Mr. Market remains alive and well. On Wednesday the S&P 500 jumped 3.0% following the Federal Reserve’s announcement that it was raising the federal funds rate by a half a percent. Come Thursday, Mr. Market went from overjoyed to dejected with the S&P 500 reversing course and dropping -3.6%.
All told the S&P 500 was down a tepid -0.2% for the week. You wouldn’t know that by reading the financial news as the commentary centered around challenging market conditions. Clearly there is more volatility in the market, which for those watching the market minute-by-minute or day-by-day may play with one’s emotions. However, we believe it prudent to expect an environment with a transitioning economy, rising interest rates, and less near-term clarity to be one where there is more volatility.
As expected, the week’s focal point was the Federal Reserve’s meeting where they decided to raise interest rates (the federal funds rate) by a half a percentage point and indicated they would likely do so again at their June and July meetings. In addition, they outlined plans beginning in June to let $47.5 billion worth of bonds mature off its balance sheet each month and then increase that cadence to $95 billion a month in September. Some market participants had been expecting the Fed to raise interest rates by three quarters of a percent, which Fed Chair Powell commented wasn’t even discussed. This fact was initially cheered by investors with Wednesday’s rally although that view quickly faded into Thursday’s session.
What the Federal Reserve did on Wednesday was lay out a course of action that will take them into September. They set a preset course for half percent rate hikes at the next two meetings and the start of a plan to reduce the size of their balance sheet that is effectively on autopilot. Any one month’s inflation report will have some element of noise, but they now have the luxury of being patient and seeing if there is progress over the course of the next four months on inflation before deciding how aggressive they need to be in September. From an investment perspective, this adds some stability and predictability, at least for the short-term.
Even though the Fed’s actions were anything but expected, the markets have accepted the reality with another round of selling pressure for stocks and bonds. Markets that are both falling and volatile can test one’s ability to focus on why they are invested, which is often for a long-term financial objective. First, we must put into context that in four of the last five years equities, as evidenced by the S&P 500, have experienced returns that were nearly 20% or more. Thus, this pace of appreciation can’t continue forever, and a pullback is not to be unexpected in light of changing monetary policy and an economy that inevitability has to cool to some degree. A reset in stock valuations has the potential to create more enduring return potential over the long-term. Among bonds, the prospect of being able to reinvest maturities at higher rates will produce notably higher income over time and provide some added support should interest rates continue to trend higher.
As Buffett once recalled a Benjamin Graham comment, “in the short run, the market is a voting machine but in the long run it is a weighing machine.” Ultimately what will be weighed over the long term is a business’ success and its underlying value. This past week we saw the voting machine in action, as votes swung back and forth. We prefer to focus on those investments that are going to maximize value on the weighing machine over the long-term.
¹The Lessons of Warren Buffett: Lessons for Corporate America, Lawrence Cunningham. 1987 Berkshire Hathaway Annual Letter.
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Matt joined the Telemus team in 2018. As Chief Investment Officer, he leads the firms the investment process and research effort. Matt has experience as an equity analyst and portfolio manager and has advised corporate pension plans on their manager selection. He’s been quoted in Money Magazine and Barron’s.