We are sticking with our preference for large cap and value after reviewing our updated models.  We also continue to think exposure to international makes sense in strategies primarily focused on thematic exchange traded funds (ETFs).  For clients with strategies using Northlake’s Market Cap and Style models, holdings in the S&P 500 (SPY) and Russell 1000 Value (IWD) will continue to be maintained.

The market sell-off accelerated in April with the NASDAQ and growth stocks leading the market lower.  In our 2022 Market Outlook published in January, we said that a below average year was in store with for the major stock averages with a greater chance for significant downside than upside.  We also predicted higher interest rates.  These forecasts have thus far proved accurate.  However, we underestimated the magnitude of the moves in stocks and interest rates.

The war in Ukraine clearly exacerbated inflation that was the center of the shift in Federal Reserve policy from easing to tightening.  What once looked like a transitory inflation phase now seems like a longer lasting period.  We do think inflation will begin to recede as we get to summer and depressed prices caused by the pandemic fall away in the year-over-year comparisons.

The problem for stock market is that the natural slowing of the economy as it normalizes post the pandemic is being met by a much more aggressive tightening policy by the Federal Reserve to fight inflation.  The Fed is determined not to let long-term inflation expectations get built into investor, consumer, and business views.  That is how inflation becomes a multiyear problem.  We think the Fed is correct to act more aggressively than planned.  The long-term inflation outlook still looks favorable given the impact of demographics, technology, and maturity of the world’s major developed economies (and China).  Thus, taking the pain now makes sense.  Unfortunately, this is a bad set up for investors as the Fed appears willing to sacrifice the economy which hits corporate earnings and stock prices.  Bond prices fall as intermediate and long-term interest rates rise to keep in sync with the much higher short-term interest rates the Fed controls through the Federal Funds rate.

We think the markets have gotten too bearish.  With the benefit of hindsight, we should have held somewhat higher levels of cash reserves.  However, Northlake’s experience and market history suggest market timing is extremely difficult.  Not only do you have time the sale well, but you also must buy back in a timely fashion.  Getting one right is tough enough!  At this point, we think investors should buckle down and ride it out.  We are confident that the current levels in the major market indices will look attractive in six to 12 months even if the correction continues in the near-term.

We have been fortunate with our strategic choices, especially the recommendation of value.  IWD is only down 4.5% since we shifted fully to value on February 1^s.  The Russell 1000 Growth (IWF), which we sold to buy more IWD is down 13%.  Large cap has not held up as well as normal in a severe stock market correction due to the dominance of the large technology stocks in the S&P 500.  International is down similarly to the U.S. stocks in 2022 but we see signs of improvement especially for emerging markets that benefit from higher commodity prices.  China’s move last week to back off its regulatory crackdown on its leading technology companies is a hopeful sign as well.  Strength in the U.S. dollar remains the biggest obstacle for international markets.

SPY and IWD are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor. Northlake’s regulatory filings can be found at www.sec.gov.