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Market and Portfolio Update

Stock markets had a well-sized and probably overdue pullback of just over 10% from high to low (as measured by the US S&P500) to start the year, which occurred mostly in growth and tech stocks. This sent many investors into a state of nervousness and uncertainty. A primary concern is how fast the Federal Reserve (Fed) and Central Bank may move to contain inflation, despite the Chair of the Fed, Jerome Powell, repeatedly emphasizing the economy's underlying strength.

To kick off 2022, most market indexes, such as the S&P 500 and Nasdaq, saw their biggest drop since March 2020. Specifically, consumer discretionary holdings were among the worst performing sectors, demonstrating a possible shift towards a late market cycle where sectors with more stability, such as consumer staples, become a more popular investment. In contrast, the energy sector ended the month in positive territory, aided by oil prices hitting higher levels.

It is important to understand that 10 to 15% pullbacks are both typical and necessary to restoring health to the markets. It is understandably alarming for many, as we never had more than a 5% pullback all last year, which is highly unusual in terms of the lack of depth and volatility. Therefore, this current pullback is really just a return to the normal.

In the final days of the month, we saw a notable nudge higher, as stocks rallied to take some of the sting out of a harsh January. However, despite the rebound, we now face a relatively flat start to an uncertain February. It’s still too early to tell where this market will go in the mid-term, but in the meantime, we have returned to the Green Zone short-term, and as such, we have started getting cash invested again. Our longer-term indicators have maintained their positive position, as this pullback was not expected to be long-lasting, which so far looks to be true.
 
What’s driving the markets?
Technically speaking, most indexes have registered solid rebounds and are now challenging key resistance levels. If cleared, these resistances could open the doors to an extended rally, turning into support that could potentially drive prices up.

Going into February, investors are looking ahead to manufacturing and jobs data, as well as more clarity on monetary policy and geopolitical tensions.

Valuations of growth and technology stocks have come under increasing scrutiny, as investors fret about companies trading at lofty valuations. As such, there will be increased investor focus on sectors that can better handle inflationary pressures, with less appetite for companies which promise future growth but currently generate negative cash flow.

The U.S. Federal Reserve last week signaled it intends to combat high inflation by hiking interest rates more aggressively than expected. “Fed likely to hike rates in March as Powell vows sustained inflation fight” (Macro Matters - Reuters) https://www.reuters.com/business/finance/inflation-fighting-fed-likely-flag-march-interest-rate-hike-2022-01-26/

The Federal Open Market Committee only said rates would rise "soon." However, Powell stated that “much was left undecided…with inflation high and for now apparently getting worse, the Fed this year plans to steadily clamp down on credit and end the extraordinary support it has provided to the U.S. economy during the coronavirus pandemic. This is going to be a year in which we move steadily away from the very highly accommodative monetary policy we put in place to deal with the economic effects of the pandemic”. The announcement widened the spectrum of possibilities of what rates could be in a year or two, which is likely to create volatility in equities. Therefore, many traders are pricing multiple rate increases by year-end.

The extent of the policy pivot away from battling the economic fallout from the pandemic and towards an inflation fight will begin to take more shape in the coming weeks. It will be contingent on how inflation itself behaves, as officials still hope to see natural economic improvement as the pandemic continues to ease.

Finally, let’s not forget, geopolitical tensions have added to market uncertainty, with threats of economic sanctions issued to Russia if it attacks Ukraine.
 
Bottom Line:
Equities were flirting with correction territory throughout January, and it is possible this drawdown may have a bit further to go as investors grapple with changes in interest rates, changes in government financial support, and slowing earnings momentum.
However, we do not think it is the beginnings of a new bear market and we remain positive on certain value-based and high-quality equities.

In mid-January we shifted our portfolios accordingly: away from growth-oriented positions, and towards stability. As of writing, our mid-sized portfolios are now back to being fully invested, and the large accounts still hold 20% cash in the equity component; thus, a balanced portfolio would hold roughly 14% cash. We have maintained these levels of cash as we wait for further confirmation that this market has changed direction.

Once we have more confidence in the market, we will look to get all portfolios fully invested. As a reminder, while we always look to position the portfolio strategically for growth opportunities, our primary focus, especially in increased times of volatility, is preservation and downside protection.
 
Please let us know if you have any questions or concerns about the markets and your portfolios, and we would be more than happy to have a call with you to provide further details.

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