Fourth of July Weekend Update

First and foremost, Happy Fourth of July! We hope you have a great weekend ahead of you filled with family and friends. It took awhile for spring and summer to arrive here in Minnesota this year, but based on the last few weeks and upcoming forecast, it was worth the wait. We hope you get outside and enjoy it!

One quick note of clarification on the email that came out from Pitzl & Pitzl this week. The CPA firm is closed next week, but Pitzl Financial is open. As such, if you have appointments scheduled or need to reach us next week, there is no need to adjust your schedule. We are around.

As far as the markets are concerned, there is no question the first half of the year was rough. In fact, it was the worst first half of a calendar year in over 50 years. The S&P 500 closed yesterday at -20.58%. Even worse, the tech / growth heavy NASDAQ finished the day at -29.51% year-to-date.

Compounding the problem, bonds took a beating as well, largely due to the Fed hiking rates at a rapid pace. The US Aggregate bond index closed down around -10% YTD.

Naturally, this will result in some feelings of concern. We will never say that those feelings are unwarranted…they are very normal. At the same time, knowing when we hit bottom is an impossible undertaking, as the dynamics at work are far more complicated than what is being reported.

Justin in our office recently commented that this is the third bear market (20% or greater decline) he has experienced since he graduated college. That translates to three bear markets in four years! We have gone through this a lot in the recent past.

He also noted that what makes this one different from his perspective is the duration. In 2018 and again in 2020, the downturns were very quick. This time, it is more like a slow leak, which makes it a bit more painful.

Are we in a recession? I don’t know…maybe. Recessions are declared in hindsight…after the fact. Data from the current quarter won’t be reported for a while.

As far as markets are concerned, it wouldn’t change much. As the chart below demonstrates, markets tend to fall before a recession occurs and start climbing before the economy does. Markets have also misfired many times where recessions never actually occurred. Markets are forward-looking, while economic news and data is backward-looking.

One of the great financial writers of our time, Morgan Housel, recently tweeted:

I’ll deviate from Morgan a touch here and acknowledge that the timing is always a surprise, but I think most investors know they happen. And no, they certainly don’t feel good in the moment.

In the current state of things, I am actually more concerned about the disruptions being caused by fund implosions than the underlying economic concerns.

Quite simply, fund implosions are the result of leverage…and too much of it. It is very difficult at any given time to know how much leverage is out there, especially in the non-traditional markets like cryptocurrencies.

This brings two of the great Warren Buffett quotes to light:

• “If you’re smart, you don’t need it (leverage). And if you’re dumb you shouldn’t be using it.”
• “Only when the tide goes out do you discover who’s been swimming naked.”

Over the last few weeks, we have seen several major funds and crypto exchanges forced to liquidate, driven largely by the incredible decline in the crypto markets.

Unfortunately, crypto funds and exchanges do not only hold crypto assets, they also own more traditional assets as well. When they are forced to liquidate and unwind, they have to sell all of the “regular” stuff too.

Unquestionably, these are awful in the moment, and you only know about them after the event has taken place. They are temporarily very painful to responsible investors.

So where do things go from here?

On one hand, there is an incredible amount of downside that has already taken place, which you have been relatively insulated from. There is not a single one of our preferred positions that is down as much as the S&P 500 (for stocks) or the Aggregate bond index (for bonds).

To provide some context to the extreme headlines and what you may be hearing from others, this is a select sample of well-known companies in the S&P 500 as of yesterday:

Seeing the likes of Amazon, Facebook (Meta), Disney and Target down 35% - 50% tells us that a lot of bad news is already priced into markets. That size of downturn is incredibly damaging. Some are calling for further declines, but how much further can they really go?

Drive to a Target this weekend and observe the flow of cars in and out of the parking lot. Walk through the store and witness the consumer spending first-hand. Inflation might create a need for some people to buy less items, but they certainly are not stopping their spending altogether.

On a forward-looking basis, every time stock markets decline, forward returns improve. Every time interest rates rise, forward bond returns improve. Both are currently happening in tandem.

Whether markets will decline more from here is nothing more than a guess, so I can’t say with much conviction where the bottom is. There might be more funds that will blow-up, or we may rocket right back out of this next week. Those aspects are not transparent at all.

However, fundamentally speaking, the market is now priced more attractively than it has been for the better part of a decade. In several parts of the global market, they are now trading at generational lows. Needless to say, I am very bullish / optimistic on the next 5-10 years, but as always, concerned about the next 5-10 weeks and months.

In addition, the aftermath of large downturns is historically very good. We are in the middle category now.

We wish we could tell you when it’s over, but that is just not something we can do. What I do know, however, is that the bottom is closer now than it was last week. And I also know that long before the economy feels better, the market will have moved on. We can’t erase what has happened already, but the only sure way to recover is to stay with the process. If we deviate and miss the upswing, there is no getting that back. On the flip side, if we stay with it…even if it drops further from here…we will still capture the inevitable upswing whenever that occurs.

Being diversified has largely insulated you from the worst of what is going on. Some of these crypto assets, hedge funds and poorly run companies can go to zero. Entire markets and well-run, unleveraged companies won’t. There is a floor of value.

Nearly $1 trillion changes hands every day in financial markets. There are buyers and sellers on both sides of each trade. The markets absolutely know that inflation is high, consumer sentiment is low, we have mid-terms coming up again, there is still a war in Eastern Europe, etc. Everything you are hearing and reading is not a secret. Put another way, markets are really just a constant exchange of information under the guise of money.

We have incorporated downturns like this into every one of your financial plans and projections. They are not fun in the moment, but they are part of the investment experience. If we didn’t experience them, there would be no risk and therefore, no meaningful upside either. What we employ from a philosophical standpoint has been through far worse than this and come out favorably on the other end.

Shut off the markets for the holiday weekend and enjoy some of this great weather!