The S&P 500 may be only 5% below its all-time high (the NASDAQ, 10%), but the average stock is doing much worse. For example, the average stock in the Russell 3000 (a broader index than the S&P 500 that includes mid and small caps) is down 27% from its high, and nearly 40% of stocks in the NASDAQ composite are down 50% or more from their 52-week highs.  The stocks of profitless and low profit-margin companies have been slammed – Goldman Sachs reports that the shares of high growth, low profit-margin stocks were trading at 16 times enterprise value-to-sales in February 2021.  These stocks are now trading at seven times EV/S.  We think investors’ focus this year will be on companies with strong balance sheets and good, consistent earnings growth.  This has always been our focus as investors, so we like how we are positioned for 2022.

Stocks are cheap relative to bonds, but will that advantage remain as rates continue to rise? In other words, can stocks perform as the Fed commits to higher interest rates?  History shows they can.  Stocks have risen at an average annualized rate of 9% during the 12 Fed rate-hike cycles since the 1950s and showed positive returns in 11 of those instances.  In a study of 15 periods when the rate on a 10-year Treasury rose by at least 1.5%, stocks averaged an annualized gain of 12% (source:  Truist Advisory Services).  Interest rates don’t always rise because of a negative event (like higher inflation).  They can also rise due to strong economic growth which drives corporate profits higher.  This rate rise is caused by a combination of both inflation and a strong economy.

Bonds are having the third worst start to a year going back 40 years. Only 2009 and 1982 were worse.  The long-term Treasury’s price is down 5.3% in two weeks, a big drop for a ‘safe’ fixed income investment.  Short-term Treasuries are down 0.5% by way of comparison.  Long Treasuries don’t provide much more yield in spite of the increased interest rate risk, which can push down prices sharply as shown above.  We would rather own more stocks than long bonds (including Treasuries).  We will stay with our short-term bond strategy in an environment where the Fed will likely be raising rates starting in March.

 

WHEN WILL TECH STOCKS BOTTOM?

 

Technology stocks have led the recent market retreat since the S&P 500 peaked on December 27th.  As we mentioned earlier in this commentary, low profit-margin and no-profit tech stocks are getting pummeled.  The main reason for the drawdown is the recent sharp increase in interest rates which causes investors to re-price growth stocks.  Growth stocks have much of their value in far-in-the-future cash flows which now gets discounted by a higher interest rate.  Another reason is the valuations on S&P 500 tech stocks are extremely high.  For example, the graph below shows that large cap tech has a higher price/sales ratio (P/S) than it did during the tech bubble:

MAJOR INDICES ARE TRADING AT SHOCKING PRICE-TO-SALES MULTIPLES

Source:  Bespoke Investment Group

What if the P/S multiple were to retreat to the long-term average?  Hypothetically, that would mean a 61% decline in the price of tech stocks:  of course, there is no reason to assume that tech should mean –  revert to the long-term average.

How can investors justify paying this multiple of sales for the tech sector?  Does this mean tech stocks are only beginning their slide?  Not necessarily.  The best single justification for the increase in multiples for tech is its astounding profitability.  For example, the S&P 500 tech sector has turned each dollar of revenue into 32.6 cents of EBITDA over the past year, a truly outstanding number compared to 22 cents at the tech bubble peak.  This equates to profit margins being 50% higher than the ‘90s tech bubble as the graph shows:

MARGINS ARE 50% HIGHER THAN LAST TECH BUBBLE

Source:  Bespoke Investment Group

Margins can’t grow forever, but with the top-line growing rapidly (about 15% year-over-year) with even steady margins, profits should continue to soar for the sector.

Tech stocks may not be great stocks in the short term, but many are great companies that can be picked up here cheaper than a couple months ago.  For example, Microsoft is off 13% and Google is off 11% to name a few.

Although we are underweight tech’s big weighting in the S&P 500, we will not hesitate to pick up great tech companies at bargain prices if the price retreat continues.  We will carefully balance growth and value stocks in portfolios with a barbell approach; value (including cyclical) stocks on one end combined with growth names (including tech) on the other end.

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Knowledge – Results

Experts in Risk Management

Are you prepared for the next market correction or financial crisis?

Knowledge – Results

Experts in Risk Management

Are you prepared for the next market correction or financial crisis?

Knowledge – Results

Experts in Risk Management

Are you prepared for the next market correction or financial crisis?

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This is achieved through an ongoing assessment of market risks given your specific financial situation and goals.

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Leadership Team

Richard Furmanski

Richard Furmanski

CFA

has been a portfolio manager and analyst for over 35 years. He manages conservative, tax-efficient portfolios for both pre-retirees and retirees. His lower risk approach appeals to investors who want less volatility and competitive risk-adjusted returns.

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Mary Ellen Adam

Mary Ellen Adam

Director of Operations

has been in office administration for over twenty years. Her experience includes customer service, firm operations, and office administration. She interacts with our clients on a day-to-day basis and handles any requests that may arise.

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Frequently Asked Questions

If you can't find the answer to your questions here, feel free to give us a call at 847-847-2505

Do you manage both stock and bond portfolios?

Yes. We build a portfolio of conservative, high-quality stocks and hold them for the long-term. The average holding period is 4 – 5 years. Our focus is on stocks that are suitable for retirement portfolios.

Our high-quality bond portfolios are designed to provide both income and stability of principal. Bonds provide the anchor for balanced accounts (those holding both stocks and bonds).

What is your investment philosophy?
We take great care in purchasing only high-quality stocks and bonds intent on a multi-year holding period. Portfolio turnover and taxable realized gains are modest in comparison to other active managers. We do not time the market but will become more defensive, in terms of stock holdings, when market conditions warrant.
Will the portfolio be managed in accordance with my financial goals?
Yes. Each of our clients has a custom-tailored portfolio. These custom portfolios are designed to meet specific client objectives with a thoughtful approach to specific constraints such as risk tolerance. And as each client’s situation changes, the portfolio does as well. There is no cookie cutter approach.
What kind of expertise do you have and how can that help me in difficult markets?
We have been working with high-net-worth clients like you since 1982. Over that time we have helped them to navigate several bear markets and financial crises (including the stock market crash of 1987). We hold the Chartered Financial Analyst (CFA) and Certified Financial Planner (CFP) designations.
Are you sensitive to taxes when managing portfolios?
Yes. Our holding period for an individual stock averages 4 plus years which means our turnover is low and realized gains can be carefully managed. Further, where possible, we tax loss harvest small losses as a way of offsetting gains taken elsewhere in the portfolio.
How have you performed?
Results will differ by client and the level of customization but we have provided competitive investment returns for many years.
How do you charge for your services?
We charge a management or consultant fee based upon the size and level of customization of the account. As the account grows, we benefit together.

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