What investors should watch in 2022…
Welcome to 2022! I hope it will be a healthy, happy year for everyone reading this.
While I’m stopping short of making formal “predictions,” here are a few things I wouldn’t be surprised to see happen this year — and that could influence how CSH helps you navigate your individual investment portfolio. Many firms invest in markets with the idea that they will go up over time, but our thoughts and strategies differ.
At CSH, we believe the market isn’t a single entity but comprised of individual stocks and bonds with varying characteristics, risk profiles, etc. It is important to understand where we are in perspective to the past — to understand how cycles work and how they, in turn, impact our various or potential investments.
As you’ll see, many interesting and complex forces are at play in 2022. It won’t be enough to take the simplistic “play the long game and ignore near-term fluctuations” approach that most of our competitors take.
Let’s take a closer look at 6 things that could have a big impact in the coming year:
- The corporate bond bubble could finally burst
- The 10-year Treasury yield could go as high as 3%
- The Consumer Price Index will stay above 5%
- Oil could exceed $100 a barrel
- Silver could hit $40 an ounce
- The U.S. Stock Market value could fall 25%
1. The corporate bond bubble could finally burst.
Corporate debt issuance is at record highs. Since the last financial crisis in 2009, corporate debt issuance has nearly doubled from $6 trillion to $11.5 trillion. That’s a massive number.
At the same time, the quality of that credit is at record lows. A full 35% of all corporate debt issuance today is “junk” (or non-investment grade). In comparison, the “junk” grade debt was only 15% during the last financial crisis.
A full 57% of the investment-grade debt is at the lowest possible rating still allowed to be considered investment grade (BBB). This means many investment-grade debts are one step away from being considered “junk.” If this came to pass, many mutual funds would have to dump their bonds on the open market because they can only invest in securities that meet or exceed the minimum rating (BBB).
The precarious state of corporate debt is a reason to watch the Treasury…
2. The 10-year Treasury yield could go as high as 3%.
Before we go any further, repeat after me…
The Fed does not control the economy.
… although they would like you to think they do.
The Fed does control the rate of interest that banks have to pay on their Federal funds.
Treasury yield is, in effect, the interest rate that the federal government pays to borrow money. Today, the 10-year Treasury yield is 1.5% — up from 1% a year ago. Sounds small, but this is a massive increase (50%!). Treasury yield affects many things, including the interest rates that individuals and businesses pay to borrow money. High long-term yields can also be a sign of rising inflation.
When inflation rears its ugly head, then the Fed can squash it by raising interest rates.
But, if the Fed raises interest rates to kill inflation, then that could put many companies with debt — like we talked about in the previous section — out of business. Now you see the problem. All this easy credit and fueling the investment bubble has resulted in a tight spot for the Fed. Can they kick the can down the road a little longer and keep interest rates (and the treasury yield) where they are? Maybe.
Bottom line — if a 3% yield did come to pass, this alone could be the death knell for many companies with outstanding debt.
3. The Consumer Price Index will stay above 5%.
The Consumer Price Index (CPI) reflects the average change over time in the prices that consumers pay for goods and services. CPI is a widely used measure of inflation.
Investor Jeff Gundlach believes that inflation from supply chain issues such as lumber, cars, and other goods will soften into next year. However, increased housing costs and wage pressures are here for a while, keeping the CPI high. Indeed, some like Gundlach believe the factors considered in calculating the CPI are questionable and the current CPI could be over 12% (instead of 6%).
4. Oil could exceed $100 a barrel.
If you’ve read my prior missives, you know that I have been an oil and gas bull since the summer of 2020. Pressures have been increasing on companies like Chevron and Exxon to grow their investments in environmental, social, and governance (ESG) assets and alternatives. As a result, they have underinvested in oil production and exploration for years. The COVID glut only exacerbated the issue. Reserves have fallen dramatically.
But, oil demand is predicted to grow to record levels. The International Energy Agency Oil Market Report, the seminal document in the industry, made an unusual move and increased all of its demand estimates over the last year. According to Goehring & Rozencwaid, a natural resources investment firm, demand for oil will exceed pumping capability in the near future. Pumping capability includes all the crude produced and sold into the market plus supply that could be produced somewhat quickly without any additional capital spending.
This has never happened before. Even during the OPEC crisis of the 1970s, demand never exceeded pumping capability.
Should the U.S. attempt to grow its shale production and head off increasing costs, drilling activity would need to increase dramatically over current levels. But this can’t happen overnight and will take some time.
The point is this: the margin of safety between meeting demand or not is razor-thin.
5. Silver could hit $40 an ounce.
When a tiny market that is capacity constrained meets increasing demand, only one thing can happen. Prices go up. Sometimes a lot.
Silver, currently at $23 an ounce, is an essential component in solar cells and electric vehicles. The automotive industry is currently using 55 million ounces of silver each year, and their usage could skyrocket with the advent of more electric vehicles (EVs). The growing popularity of EVs could strain the productive capacity of silver mines, primarily in Mexico, Peru, and China. Because silver is essential to the growing EV market, automotive companies will find a way to ensure their access to this resource.
During a private Q&A at a recent investment conference, Keith Neumeyer, CEO and president of First Majestic Silver, said, “Silver is so critical to automotive production today that in 10 years I believe there will be no more publicly-traded silver companies.” Automotive companies are already considering the vertical integration of owning silver mines themselves. It’s simply mission-critical.
And that means silver’s value is poised to increase in 2022.
6. The U.S. Stock Market value could fall 25%.
This is another bubble kind of conversation. (We’ve had a lot of those lately.) Bill Nygren of The Oakmark Funds put it this way. “This isn’t anything like the internet bubble. Not like 1999 at all. While there are many investments or companies selling at extremely high valuations, we’re finding great values at the low end and with the great big companies. 1999 was across the board overvaluation.”
Think of it this way. The Price-to-Earnings (P/E) ratio for today’s market is valued at 25X earnings. That means for every dollar of investment, you are getting back 4 cents in the form of earnings. There are many companies trading at 50X and above that will never make a profit. But, there are almost as many companies trading at 10X earnings that are very profitable and attractive at that price.
A fall of 25% in the market might sound a little scary, but it may signal an encouraging course correction — that we’re finally recognizing some undervalued stocks and right-sizing some overvalued ones.
In the dismal days of the summer 2020 markets, CSH was able to monetize our hedges and invest in some really attractive compounding companies. Having those hedges gave us cash to invest, and that was the most fun I’d had in a long time in this business. It sounds counterintuitive, but it is so true. When you’re prepared, it totally changes your mindset.
Closing thoughts…
At CSH, we’re keeping an eye on these and many other fronts as 2022 gets started. While it can be comforting to keep a high-level, long-range view, it’s prudent to remember that our market is made of individual stocks and bonds with varying characteristics and risk profiles. Today’s performance must be viewed in relation to the past, but also with an understanding of cycles and their impact on our various current or potential investments.
If you are an existing CSH client and have any questions or concerns about your investment allocations, we are always here to speak with you.
If you’re not a CSH client yet and want to ensure you’re starting the new year from the strongest possible investment position, then please give us a call at 217-824-4211. We would be more than happy to speak to you about your current situation and analyze ways it could be better. We are a fiduciary, and this means we always act with your best interests in mind!