In our end of the year investors’ letter, we indicated our forecast for some difficulty ahead. The market, so far, has certainly delivered; indeed, we are facing one of the worst starts in recorded market history.

The almost 18% correction in the SP500 index puts us in sight of the demarcation line between a bull and a bear market (-20%), while the Nasdaq is well past that mark being down YTD over 26%.  Bonds, one of the big culprits in this correction, are down, depending on the index of choice, in the high single digits.

The only bright spot is commodities with energy up double digits, a second year in a row of outperformance.  Conversely, gold, a typical inflation hedge, has been flat to modestly higher.

The convergence of inflation, rising rates, war, and high starting valuations have proven too much to bear for investors in spite of Q1 earnings still in pretty good shape.  A key element to future performance is when inflation is going to peak.  There is some good news that the recent CPI reading at above 8% might indicate the worst is behind us; however, the tight labor market and the constant supply interruptions out of China lead us to believe that as inflation will undoubtedly start coming down shortly, it may still remain way above historical averages for a while.  How quickly inflation subsides will be the defining element in forecasting the Federal Reserve monetary policy action.  Even Jay Powell, Chairman of the central bank, has admitted that “soft landings” are hard to execute.  In other words, the probabilities of a policy mistake that eventually leads to at least a small recession are high.

From a technical perspective, the good news is that investors mood is generally quite negative as indicated by a variety of polls including the notorious AAII Bull/Bear index.  Also, from a qualitative angle, we see more stories on media outlets cautioning against buying the dip and explain in great details how much more downside is below us.  However, a few technical indicators that supposedly should help us quantify such somber mood are not quite in “panic” territory.

The generally reliable CBOE Put/Call Equity ratio is not indicating widespread capitulation by investors. The ratio is sitting at .83 which by historical standard does not implicate uncontrolled fear, a solid contrarian indicator.  A similar index, the VIX, which measures the expected volatility of the market index by computing how much investors are willing to pay for insurance for such future volatility, is also at high levels but quite far from indicating panic.

Barron’s reminds us that of the 12 bear markets since WWII, 9 lost at least 25%. Three were particularly difficult, 1973, 2000, and 2007 with losses of more than 40%. 

At this point, it’s a waiting game, where inflation and China call the shots. Owning good companies with long term franchise value and quality dividends should make the wait a little easier.