Yesterday’s CPI report showed prices up 7.9% YoY, which was the highest reading since 1982.  Even more concerning, this was before the impacts of the Russian/Ukraine war is reflected in the data.  Market volatility is exceptionally high and pessimism is quite pervasive.  There are legitimate fears that inflation in excess of wage growth could cause a recession.  The stock market is pricing in a mild recession, reflected by the Nasdaq bear market and the correction in the other indices. We have never seen sanctions like we are seeing imposed and the impacts will touch each one of us in many ways.  Russia and Ukraine are huge suppliers of wheat, oil, natural gas, nickel (for stainless steel), among many other resources.  We can expect supply chain problems to magnify and higher prices to persist.

The stage could potentially be set for a Russian default, while many other emerging markets are susceptible too.  By kicking Russia out of the banking Swift system, the U.S. is forcing Russia, and probably pushing China to some extent, to develop alternatives to a dollar-based trade system.  We’ve also seen western companies shutting down operations in Russia that had been cultivated since the early 1990’s.  In some respects, we are seeing breakages in the globalization system, which has dominated over the last 30 years.  The long-term impacts of these decisions could be felt for decades.  While one can certainly understand the sentiment due to the despicable invasion of Ukraine, I’m not sure the pluses and negatives have been properly calculated.  What is the impact of food shortages stemming from this in Africa for instance?  There are so many questions and the best answer is peace, as the sooner this war ends, the less disastrous the multivariate consequences will end up being.

Given this tumultuous backdrop, it is easy for investors to get nervous or scared, which is more than understandable.  Market participants always dream about buying stocks at a 20-30% discount, but often they think that these corrections will happen while their sentiments and emotions about the stocks will be the same, which is almost never the case.  It is when things look bleakest that the best opportunities emerge.  I’m not saying that time is now, but we are closer to it than we’ve been since the Spring of 2020.  I see parallels to the summer of 2011, when many thought that the heavily indebted European countries such as Italy and Portugal were likely to default.  Those periods of distress were very good buying opportunities and I think we are seeing some majorly attractive opportunities opening up.

Fortunately, we came into this year with a very conservative outlook and strategy.  While we didn’t forecast this war and especially not the scale of this war, we were very much ready for a stock market correction. We locked in profits on many of our long-term positions at very favorable prices, and we have utilized disciplined options strategies to take advantage of volatility, manufacturing extremely cheap entry-prices into stocks if we ultimately get exercised.  If all our stocks traded at current levels when the majority of our options expire, we would end up solidly profitable on the year despite the bear market in the Nasdaq and major global correction.

Over the past two years, I’ve made a lot of comparisons of the current environment and the Tech Bubble in 2000.  When that bubble popped, the Nasdaq dropped by 80% over the following 3 years.  The ARK Innovation fund, which is the best proxy for the really expensive tech sector, is now down 62% from its 2021 high.  The carnage is very real and many big name funds are down 20-30% YTD.  I don’t know when the bottom will hit, as the Russia/Ukraine war could potentially end at any time, but I do know that we can take advantage of this volatility by selling puts and buying stocks that are deeply undervalued, and having a long-term perspective.  The global banking sector has never been better capitalized or more liquid, so disruptions such as potential defaults in emerging markets shouldn’t pose any systemic problems.  This is why I think we can avoid a Financial Crisis-type scenario. The US bond market is down 6.6% from its peak in August 2020, which is the largest correction in recent history.  This has all occurred before one rate hike, so it could potentially get a lot worse for bonds if inflation persists, so there are few places to hide, which is why we like the opportunity with options on undervalued stocks so much.

The tailwinds of low unemployment and the fading of Covid-19 are major positives, although a recession is very possible if high inflation persists well into the year.  Recessions are inevitable and many of the best buys come as a result of them.  We will keep upgrading our portfolios’ as opportunities permit.  Things can change quickly and I think if we see news of a durable ceasefire in Ukraine, you could see a very substantial rally, while many commodity prices would probably drop, lessening the inflation pressure.  If the war persists, we will get through it and will be happy to be using the tools we are using to reduce risk, which are simply not available if you only own stocks and bonds.  I’ll keep providing updates during these stressful times and while the risks facing the global economy are high, a decent amount of that risk is being priced in currently.  I feel very good about our prospects of coming out of this in good shape and really capitalizing as we see the light at the end of the tunnel.