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May 2022 Monthly Review

"It's a little like Tetris"

By Loyd Johnson, Chief Investment Officer
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Loyd Johnson PhotoA Look Back

My youngest just graduated from 8th grade and one of the keynote speakers made an analogy of their class journey so far and what was ahead of them using the old-school video game, Tetris. He talked about the game and how the goal is to complete horizontal lines as differently shaped pieces (tetrominoes) descend onto the playing field. When the game first begins, players have more time to decide how to optimally arrange the pieces for success. As the game goes on, the pieces come at you faster and faster, and the player must make decisions much quicker.

His reference was that, like the insurance commercials, life does come at you faster as you get older and you need to get better and quicker in dealing with what it brings. I believe the analogy holds when thinking about financial markets, and the cycles that they tend to go through. Significant market run-ups…which can often lead to bubble scenarios are typically followed by significant downturns. The big unknown in all of this is the important variable of time. How long can bubbles exist? When do they end? When will the recovery start? Those types of questions are truly the difficult ones, and the ones that are really only known with the benefit of hindsight…or crystal balls.

However, it does not mean that we just throw our collective arms up in hopeless despair. There are important lessons to be learned from history. I think back to The Great Recession time frame of 2008-2009. There were great excesses in the housing market in particular, which lead to various market disconnections, individual company collapses and market downturns. As we got to those excesses, markets performed exceedingly well from the last market retreat brought about by the “Dot Com” bust of 2002.

Similarly, we had a long and strong bull market in stocks from March of 2009 all the way to January of this year. The S&P 500 advanced from a low of 666 in 2009 to 4818 by January 3rd earlier this year…or +723%! Similarly, we were making the case in late 2019 that markets were already starting to look stretched from a valuation standpoint. Then, of course, Covid came along in early 2020. After a quick market decrease in February and March, and buffered by historic government stimulus and Fed accommodations, stocks rallied to not only make up earlier losses, but made new highs by the end of 2020.

With additional stimulus and an ever-ballooning Fed balance sheet, stocks continued their run into 2021…even as the pandemic with its supply-chain issues and increasing inflation frustrated consumers across the globe. So, here we are…again. The drivers are certainly different, but the result is much the same. The only way valuations can get really extended, and potentially lead to bubbles, is by investors consistently bidding up asset prices…and like the game of Tetris, as the game goes on longer…the pieces start to come at you faster. Now, with inflation at elevated levels, the Fed has to be much more precise and correct in their actions to engineer the kind of economic “soft landing” they so desire. After an ugly start in the month of May, most asset classes rallied in the last week to end the month in positive territory. In some cases, it was the first time this year.

A Look Ahead

The look ahead is brief this month. We believe it is most likely that volatility will continue in 2022, with relief rallies and subsequent down moves as the Fed continues on their path of rate hikes. Inflation may moderate a bit, but remains a headwind. We do believe that the Fed will eventually get the job done. The question will be how much pain will be involved getting there. We still believe in the long-term staying power of our markets, but remain on the conservative side as the puzzle pieces still need time to fit together...