Being Right Only Matters for a Day | Denewiler Capital

Observations on the Market //

Being Right Only Matters for a Day

Written by Greg Denewiler, CFA® // December 28, 2022

Everyone would agree that this has been an interesting year. Virtually nothing has gone according to plan, or more precisely, as predicted. The Fed completely missed the inflation call – it was not transitory. The bond market has had one of its worst-performing years in history. So-called “safe” bond assets declined as much as the stock market, and some sectors performed worse. Then there is the question of whether we are/were in a recession or not. Even though the economy did experience two consecutive quarters of declining Real GDP earlier this year, (which normally is the standard definition of a recession), the experts have decided that we cannot be in a recession at the same time we have full employment. Russia and China complicate the story even more.



In January it was predictable that Russia would not defy most of the world and invade Ukraine, knowing that it could have serious consequences for their own economy. Wrong again. What is even more amazing is what happened in China recently. Everyone knows that the Chinese government is not bothered by public opinion. If you oppose the Chinese government and live in China, you are literally putting your life in someone else’s hands (the Chinese government’s). The government does not take kindly to protesting, yet some Chinese reached the breaking point last month and protests started to break out across the country regarding the Covid lockdowns. With absolute predictability, the government reacted against them. Then something unexpected happened, the Chinese government completely changed course and basically capitulated to the protestors. Who saw that coming? All these events have made the business of predicting, and especially predicting commodity prices even more difficult.



The Russian war had a major impact on commodity prices, but now it is as if the war never happened. Crude oil began the year in the mid 70’s per barrel, went to a high of $120, and has since fallen back to $80. Since Russia and Ukraine are major wheat producers, wheat went from $7.60 per bushel in January to $13 a few months later. We are now back down to $7.70. Lumber has declined over 50% from its January high and is now down 70% from the high earlier this year. Gasoline, the commodity everyone sees priced daily at the pump, has also completed a round trip back to its beginning of the year price. Gasoline prices in the futures market have gone from $2.30 per gallon to $4.20, and now back to $2.38. Commodity prices are not the only contributor to inflation. Labor costs are still rising, and housing costs, including rent, have yet to soften much. The latest inflation report still shows prices up 7.1% from a year ago. Gold used to be considered THE investment if you wanted an inflation hedge. Not so much now. It started the year at $1,800 but has only managed a move to $1,820. That either suggests inflation is about to cool dramatically, or gold is no longer a predictor of anything. We will see.



It is human nature to be drawn to the investor who has had a strong track record recently for some insight into what the future may hold. If a manager’s model portfolio is up 5% for the year, versus the S&P 500 which is down 18%, you are probably thinking “I should be reading that newsletter.” Well, you are. Now for the conclusion you are not expecting.



We do not invest according to specific models given our portfolios are all somewhat different depending on the client. However, we do have a portfolio that has only been invested in 10-12 dividend stocks since 2010. We use it as the foundation for our dividend growth strategy, and to ensure our approach is working. In general, the dividend sector has done well this year, but our portfolio has done even better. However, please note that if you think that anyone’s advice is more relevant because of recent performance, you are in for a very unpleasant surprise. Unfortunately, the investment industry lives on the concept that recent performance indicates someone’s ability to predict the future. All investment strategies cycle in and out of favor given enough time. Everyone has periods of being hot or cold. Fortunes can change fast, just ask Cathie Wood or Elon Musk. This is the point that matters; the model portfolio’s income is up 22% this year. It has averaged over 9% annual dividend growth since 2010, while the S&P 500 has grown its dividend by a similar amount over the same period. Here is the big advantage of predicting income instead of price. In 2023, the income should grow by at least 5% because all the companies have already increased their dividends during the year and dividend payments are much more predictable, so they will pay more in 2023 than they did in 2022. There is a 75% chance or better that the income will grow by at least 10% due to strategic reinvestment in 2023. However, predicting the price or value of the portfolio next year is totally unknowable. Why don’t more investors predict income instead of price? Probably because it takes years for compounding to make a significant difference and most investors don’t have the patience. Even if the portfolio value declines by 20% next year, once compounding kicks in, it changes everything.

Happy New Year


Observations On The Market No.378