Happy New Year

2022 was full of surprises for investors!  For the first time in 50 years we had both equities and bonds decline while commodities climbed.   How do we position a portfolio to handle the unknown?




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Transcript

Happy New Year
Season 3: Episode 1

Katz: Welcome to The Real Spiel with Ryan and Kurt. Hope everyone had a wonderful holiday season and Happy New Year to you all as we kick off 2023. We felt it would be a good time to review 2022 and what's happened in the markets. We saw equities get beaten up a little bit down about twenty percent broadly. Bonds also struggled, equities and bonds down at the same time for the first time in fifty years. Meanwhile commodities are up twenty to thirty percent, depending on the benchmark that you look at. Kurt, where does that leave us heading into 2023 and what do you think we're going to see in these different markets? 

 Nelson: Hey Ryan. Happy New Year. 2022 had a lot of surprises for us. As you mentioned, we had stocks and bonds decline for the first time in half a century. If you think back to, you know old-school investment philosophy, we talked about the sixty-forty portfolio that you'd have sixty percent in stocks, forty percent in bonds. Of course, that's advanced significantly over the last twenty to thirty years. But those were the major tools that you know, risky assets that investors used to diversify, and they both declined at the same time. That's not a good thing. Because you really want that diversification where one zigs and the other zags. If you take even a deeper look at 2022, it's a more troubling picture than just that surface perspective.  You know, if you think about the Yale investment endowment model that's been incorporated by a lot of RIAs, advisors, as well as institutions. There's been a diversification on the equity side into developed Europe, developed Asia, emerging markets. But all of the stock markets declined last year on the fixed income side. You could do, you know long-term government bonds, you could do high-yield debt, you could do debt in Europe, debt in Asia even structured credit. But all of those declined as well. And even going further, you know, gold did not have a great year in ’22 and rates actually declined as well. 

 So, when you think about where to hide, where can you go for a positive return? Commodities really lead the charge as you said. Depending on your benchmark, whether it's a Bloomberg commodity Index or others and returns for the full year ranged from fifteen to thirty percent and in a positive way. So, the 2010s offered, these incredible financial returns to stocks into bonds and challenging commodity returns and we've seen that completely about face. I think the biggest thing is that we learned that inflation is not transitory. The fed has owned that now, after a year ago kind of giving us the story that this was going to be temporary supply chain driven, COVID driven, and this was going to mitigate on its own. What we found is that COVID is still here, China is still wrestling with reopening of their market, we still have supply chain issues, and now we have other kind of ingrained inflationary effects such as like higher wages. Still tight, unemployment, and your competition for labor. So, all of that along with higher real estate prices is driving higher and higher rates of inflation. Even if inflation moderates from nine to eight to seven percent. Maybe we get lucky, six percent, five percent were still way above the Fed target. The Fed wants inflation to be, you know, long-run at a two percent average. So, my expectation Ryan going forward is that the Fed is going to continue to have a hawkish policy on inflation. They may not be raising seventy-five basis points per meeting. Maybe they raise fifty or twenty-five basis points. But until they see a significant trend downward in inflation, I think we can continue to see the challenges in ’23 and beyond that we saw in ‘22 to these traditional markets. I guess what I would add is that this is great for commodities because commodities are the prices of things. And if prices are going up that translates into PPI and CPI, and that flows, you know, into these fundamental prices of commodities, whether it's energy or agriculture or metals. 

 Katz: Absolutely. And I just wanted to quickly touch on commodities given the significant run-up that we saw in 2022. I mean, we've talked about, you know, the historically low inventories that were sitting at broadly across commodity sectors and specific commodities. We have supply chain issues still lingering. You've got you know, geopolitical conflict issues with Ukraine and Russia. You have weather disruptions, drought conditions here domestically and abroad as well. What kind of tailwinds do you see for commodities going into 2023 given we've already seen kind of this run-up? Is there still some room to go for commodity returns?

 Nelson: So, our investment philosophy is driven around scarcity and inventories. So, if you think about supply and demand, it is so the classic economics 101 story. And it applies to commodities completely directly that you know, when it comes to crude oil prices or say, copper prices is a function of how much supply do you have and how much demand do you have? Where supply and demand meet is what we will call inventories or buffer stocks. So, if we have large amounts of copper and storage and you have an increase in demand or a decrease in supply. But you have ample storage and warehouses to deliver. It's not really going to have a big impact. Where things get really exciting and dynamic in the markets is when inventories are low. Because then if you have a negative supply shock and you know, it could be in coppers case, it could be labor strikes or political problems in Peru or Chile, it could be increased in electric vehicle and renewable energy demand that's new that the market hadn't anticipated or were priced for planned for if there are no inventories or buffer stocks to deliver than the only thing that can give his price. So, you'll just see price increase significantly. And not only is there a spot price effect, But the price insurance return, which is delivered to futures investors is amplified as well based on all of our research. I think it was really interesting right now, Ryan, is that we're seeing inventory levels right now across the energy complex, across metals, across grains and agriculture are at five year plus lows, and we measure this on a seasonal basis. So, we look at where we are in January 2023. And we compare it to you from January 2016-2021. So, some commodities are seasonal, and some are not. But if you're comparing January of each year to you know to each other, I think that's a reasonable comparison. And what we're finding is that across metals, energy and across grains and oil seeds we’re at or below the five a year prior low for January of each of these commodities that to me seems like a great setup. Because, you have a very unbalanced coin right now. It's not fifty fifty. You know, if there's any shock to supply or demand, there are not sufficient buffer stocks or inventories to meet that demand increase or supply decrease and the only thing that can give is price. 

 Katz: Sure, it does seem like there's still plenty of tailwinds for commodities. I wanted also just quickly pivot over to equities. You know, especially growth stocks have been definitely beaten up in 2022. It's rapid, you know, increasing and rates. And you know, most economists aren't looking at maybe any rate cutting until at the end of 2023. We're likely to still see some tepid increases until, you know, maybe Q 4 of this year Q 3. You know, it's obviously uncertain. But most economists are looking not at cuts until potentially Q 3. I'm sorry Q4 of this year. Or maybe even Q1 of 2024. Are there any equity, you know, sectors or areas that you feel like maybe could outperform or you still think it's kind of a bleak outlook for 2023 on the equity side. 

 Nelson: No. I think equities still play a role. I mean, I think the job of any allocator is to diversify. So, you want to understand that you can have an outlook for the future, but your crystal ball for anybody, including the Fed is going to be imperfect. And so, the best thing you can do is diversify. And that said, within the equity space, I like natural resource equities. So, things that are related to MLPs, related to energy infrastructure, mining infrastructure. I think those are very interesting. I also think that we've seen this resurgence for the first time. Maybe in twenty years, Ryan, it's been a long time of value versus growth is going to be entrenched for a few more years minimum as investors aren't looking for exponential growth with zero profit. But what they're looking for is is steady profitability with a defensive, resilient business model. And we've seen that if you think about the Facebooks Amazons, Tesla's, the Google you've seen or alphabet, you've seen this this pullback in tech stocks. But you've seen value stocks that are profitable and resilient doing much, much better on a relative basis. I think we'll see that in natural resource equities, and I think we'll continue to see that and in value equities but with respect to the macro landscape, I mean, I do think we're probably going to see tighter credit conditions, higher rates for longer. There's been a lot of wishful thinking that things would ease and get better. 

 Katz: Thank you all for listening this week. If you have any questions, comments, feedback we'd love to hear from you at therealspiel@USCFInvestments.com.

 Thank you again and we will talk to you next week.