2022 The Year of Jumping Sharks
David Edwards:
I'm David Edwards, Heron Wealth in New York City, Buff Parham in South Carolina, Parham & Associates.
David Edwards:
We are doing our end of the year webinar, and I decided to title this webinar “2022, The Year of Jumping Sharks.” If anyone is not familiar with that reference, it came about from the TV show, Happy Days, back in the 1970s. It was a very popular show. I watched it when I was a kid, and after a few years they started running out of good ideas for plots. So Henry Winkler, who played the character of the Fonz said, "Well, I'm a really good water skier. How about we have this episode where I jump over a shark tank as a dare?" The director and producer said, "That sounds like a great idea," so they did it. Actually, that was 1977. In 1976, Happy Days was most highly rated show on TV.
In 1977, the year of “jumping the shark,” Happy Days was the second highest rated show. When it finally went off the air in the early 1980s it was 63rd. So people said, "Yeah, Happy Days was a great show, but eventually they ran out of good ideas. So to keep the thing going, they had to come up with all kinds of crazy stunts." So that concept of jumping the shark has been applied to many creative endeavors over the years, and also personalities, but you could also use it for analyzing investments. Everything is a trend until the trend starts to peter out. They love you at the beginning and then they hate you at the end, and where does the transition to decline occur? So we're going to spend the next half-hour talking about a number of important trends of this past year and discuss those that have jumped the shark and those that still have a way to go. Buff, why don't you start jumping in with some of the questions that we got.
Buff Parham:
Well, I think we should start with the number one topic of 2021, which is COVID-19. What do you think?
David Edwards:
I started these webinars in March 2020 because we were frantic about COVID. We didn't know what it was. We didn't know how it would kill us. Did we have to wipe things down with bleach? Did we have to get gas masks? What was it all about? It was a pretty bad experience for many Americans. Half of the population got COVID, 1.1 million died. Well, I finally got COVID last month, and the only reason why I know I had COVID was because I wanted to fly down to Florida to spend Thanksgiving with some friends. I took a test in advance and I tested positive. "What?"
Buff Parham:
Yeah.
David Edwards:
I went, got a better test, but I was still positive. It turned out that I had picked up COVID somewhere along the way, which has been the experience of a lot of people this year. But because of science, because of vaccines, it was nothing for me. I've heard from a number of other friends and clients in the last six months or so of that all got COVID after avoiding it for the first two years. All diseases become more transmissible and less lethal as time goes by. If the disease doesn't transmit, then it dies out. If it's too lethal, it dies out. So the first strains of COVID were not super transmissible, but extremely lethal. Now it's very transmissible, but not so lethal. It's right up there with the flu and RSV and a couple of other things for inconvenience. So we've gone from the pandemic stage of the disease to the endemic state of disease. People will be dying of COVID still. We'll be getting annual vaccines going still. But thanks to science, thanks to vaccines, it's no longer a significant part of our world. It has jumped the shark.
Buff Parham:
Amen to that. Well, energy prices, at least gasoline for that matter, have come down dramatically. The border inflation number hasn't followed suit. What's going on?
David Edwards:
Energy prices plummeted to negative in April 2020. One of my clients called up and said, "Hey David, can I get some of that negative gasoline?" I said, "Absolutely, if you don't mind storing it in your basement." Then gas prices rebounded from zero to let's say $3.00 a gallon, and they'd probably be at $3.50 a gallon throughout the whole year, except that the war broke out in Ukraine. The Russians invaded and disrupted European energy markets. We talked earlier this year about how it takes time for energy markets to reconfigure. The Russians aren't shipping their oil anymore to Western Europe, but they are shipping their oil to India and China, which means that the Indians and Chinese are not buying oil from the Middle East. Meanwhile, the Americas ramped up their production. So energy prices bumped way up because of supply constraints and then supply adapted, world trading patterns changed, and now prices have gone the other way.
Just in the last month, the price of gasoline fell to a level lower than this time a year ago. Now, it still takes time for inflation to work its way through, and there are other things going on with inflation. So we're not dropping right back down to the 2% in that prevailed for most of the last decade. What are the other components of inflation? Housing prices are a huge component of inflation, and it's the rent part, not the buying part. The United States has systematically underinvested in new property development for the last decade, we don't have enough housing. Why don't we have enough housing? Well, because many municipalities have such a rigorous permitting process that it's very hard to get new construction going. A lot of municipalities won't allow multi-family houses, won't allow apartment buildings. Well, that's the fastest best way to get cheap housing out there.
But if you live in Greenwich, Connecticut, you are opposed to an apartment building because that would devalue your property. So I don't see inflation from housing going down anytime soon. That's a big problem. Then food prices, we've had trouble with eggs. Why eggs? Oh yeah, there was an avian flu outbreak, 60 million chickens had to be killed to get the flue under control. Now we don't have enough chickens laying eggs. The cost of diesel is a huge impact on food prices because you got to pick the tomatoes in California and put them on a truck and take them to Connecticut. Food inflation will come down eventually. The last piece of inflation this year has been supply chain constraints. China's economy has been stop, start, stop, start, stop, start, stop, start. For the last year as they had this zero COVID policy. If there was a single case of COVID in the city of Shanghai, they would shut down the entire city. That policy did not work very well.
The Chinese are very vulnerable to COVID. There's a huge surge right now, could potentially lose a million people, but also blow up factory production. All of a sudden you can't get stuff from factories that ships from ships across the ocean, from oceans to California, from California on to a truck, from truck to Kansas or Chicago or Florida or any place. So all of these things have created inflation and I call that war inflation; the war from the Ukraine and the war from the pandemic. But good news, inflation was 9% earlier this summer. It's fallen back to 7%, 7.1. It will continue heading south as we get into 2023, probably to 4%, is where it will be. Then after that, to three and then 2%. So it took a while to ramp inflation up to 9%. It'll take a while to drop it back down to 3%.
Buff Parham:
Well, how big a role is the Fed's manipulation of interest rates playing right now?
David Edwards:
Historically, people thought that, "Oh, the Fed will just raise rates and that will slow down the economy and everything will be fine." Well, raising interest rates doesn't fix the war in Ukraine. Raising interest rates doesn't fix supply chain problems in China. Raising interest rates doesn't grow more chickens. So the Fed is as much a spectator on inflation as the rest of us. The Fed raised rates at the fastest, sharpest rate in the history of Fed raises. We had four increases of 75 basis points. We had another increase this past week, a half-a-percent, a couple of increases over this year. So we went from 0% to 4 1/2% in a very short timeframe. But the economy does not seem to be that affected by it. The one part of the economy that is affected is mortgage rates. Mortgages were 3% at the start of the year, now they're 6%. That's definitely put a damper on home sales and house prices are coming down a little bit, but again, there's not enough supply of houses, so it has only a modest effect on inflation.
Buff Parham:
We've watched the tech sector led by the FAANG's dive by percentages that are double that of the S&P this year. What do you think the primary factor of that spectacular downturn was all about?
David Edwards:
The FAANG stocks are Facebook, Apple, Amazon, Netflix, Google, the large cap growth stocks. They were the one decision stocks to buy for most of the last five years, soared to trillion dollar market capitalizations. From the start of the year to this past week, they fell on average 43%. Apple was doing the best - down about 27%. Facebook was doing the worst, down about 67%. The way of understanding why these stocks can be flying so high and then falling down so sharply has to do with the different kinds of companies that are out there. There are four kinds of companies that we can possibly invest in. The first is what we call a “question mark” company. It's a great opportunity, it's growing fast, but it's cash flow negative. You don't know if it's going to survive.
Tesla is still a question mark company. It's going very fast, but it's cash flow negative, unprofitable.
The companies that are more interesting to us are what we call the “rising star” companies. These are cash flow positive, very profitable, and growing very fast. That is Amazon, that is Apple, that is Netflix and Google, Facebook, but the problem is they can only grow so big so long. Now that Amazon has taken over all of retail for the United States, where are they going to grow next? So every rising star company transitions from “rising star” to “cash cow”; still profitable, still cash flow positive but growing at a much slower rate. Microsoft is a cash cow. J.P. Morgan is a cash cow. IBM is a cash cow. When you go from rising star to cash cow, the price that the market's willing to pay for your future earnings drops off dramatically.
We talk about PE ratios. Let's say Amazon has a PE of 40. For every dollar you put in to buy Amazon stock, it takes 40 years to earn that back out of earnings. But if the earnings are going very quickly, you'll be patient for that. But once the earnings slow down, well now the PE drops to 20. I'm only willing to wait 20 years to get my dollar back. So you get a big down shift in the stock price as it goes from a 40 PE to a 20 PE, but then there's things that are specific to certain companies. Facebook's business model, I think, is not a very good model. There's two companies that you can invest in, Google and Facebook, that both do online advertising. But the difference is that, "Every time I want to buy something, I use Google."
I go and actively search for products and services on Google, which delivers ads specific to that search. While using Facebook, I'm there for some other reason. I'm looking at my friends’ pictures or trying to organize a college reunion, whatever. There are peripheral ads on the side, but I'm not interested in those ads. I'm not looking for something right now. Even though Google and Facebook are both in online advertising, I don't think Facebook has a robust business model.
I think social media jumped the shark this year. Back in 2012 when Twitter and Facebook first exploded onto the scene, it was really cool to have a Facebook page and something you looked forward to. You could check out your friends' adventures and post about your parties and tag things. It was really great.
Well, now Facebook is drudgery. I'm organizing a college reunion right now and I'm going into people's Facebook pages to get caught up with them. My classmates haven't posted in three years, five years, they don't care anymore. We used to advertise our business on Facebook. We stopped a couple of years ago because our typical prospects have lost interest. If I look at my kids' Facebook pages or the Facebook pages of some of our younger clients, they haven't posted since 2014. So what used to be fun and thrilling and exciting is now drudgery. Same thing with Instagram, same thing with TikTok, Twitter. Twitter is-
Buff Parham:
Let not leave out Twitter.
David Edwards:
Twitter has definitely jumped the shark.
Buff Parham:
Yes it has.
David Edwards:
We actually closed down our Twitter page for our business because I don't want my company associated with the crazy people. We can actually roll into Elon Musk and Tesla as another example of what has jumped the shark.
Buff Parham:
Yeah.
David Edwards:
Tesla used to be the coolest thing on the block.
Buff Parham:
Right.
David Edwards:
If you were an East Coast liberal elite, you could signal your East Coast liberal eliteness by buying a Tesla.
Buff Parham:
Yep.
David Edwards:
I don't think you're going to do that now.
Buff Parham:
Not anymore. No. He's been very oblivious to the source of his market, if you will.
David Edwards:
Yeah. It's also, in my mind, Elon Musk used to be like Tony Stark, Iron Man, this billionaire scientist who's making amazing things. Well, now I'm looking at how he's running Twitter and wondering, "Gosh, is he doing an equally crappy job building cars? How am I going to get into that car?" But here's another thing that might have jumped the shark this year, gasoline- powered vehicles.
Buff Parham:
Yes, indeed.
David Edwards:
We've been driving gasoline-powered vehicles for 100 years, and I'm not saying we're going to stop tomorrow. However, at the past Super Bowl, there were seven ads from seven different mainstream car companies for, Toyota General Motors, plus a couple of new companies, Rivian, for example, all promoting their electric cars. Audi, right? Cadillac all have electric cars. So the Tesla, kind of looking like a Toyota Prius at this point. It's small. It doesn't have a big hatchback to carry all your junk? It's a nice backup car if you want to go to a country club or maybe as a commuter car, but as the kind of car you take to Costco or Walmart, oh, you can get other much better cars. I happened to buy a new car in the summer of 2021, so a year ago. I'm reasonably confident that's the last gasoline-powered car I'm going to buy for the rest of my life.
Buff Parham:
I think you're right about that. We don't know, but if they were to do a survey of asking people, "What do you think your next car purchase will look like?" My son sells Audis and he says the EV demand is off the charts.
David Edwards:
Absolutely.When you have an electric car, you don't need to worry anymore about if gasoline is going up or down. Most people can put a grid on their roof and power their car at home every day.
As I drive across America, I see more and more solar installations on roofs and more and more windmills everywhere.
Buff Parham:
One more head spinner here. The implosion of crypto and obviously the FTX fiasco's drawn a lot of attention to it.
David Edwards:
Yep.
Buff Parham:
The obvious temptation is to say, "I told you so," but you think the regulators have waited too long to step into the mess?
David Edwards:
I absolutely forbid my clients to get involved with crypto.
Buff Parham:
Good for you.
David Edwards:
I said, "If you want to buy crypto, you can do it on the side or you can fire me first. I won't let you buy crypto." "Well, why not, David? All the cool kids are buying crypto." I go, "Yeah. Well, let me describe the business model for crypto. It's worth nothing. It requires an incredible amount of energy to keep it going, but you can lose 100% of your money overnight. What are you buying there exactly?" So trends come and go, whether it's crypto or Beanie Babies or Dutch tulip bulbs or South Sea's stock, there's always a fantasy investment that if you just buy it, you'll solve all your problems.
It's a tale as old as time. The bitcoin market peaked in January '22, so 12 months ago, and it was worth about $3 trillion. Now it's worth maybe $750 billion. So we've had about a, 75% loss. The two cryptos that are still hanging in there are Bitcoin and Ethereum. But Bitcoin fell 20% when Sam Bankman-Fried announced that his company was bankrupt. I love when people said, "Oh, he was worth $32 billion, now it's worth zero." No, no-
Buff Parham:
No, he wasn't.
David Edwards:
He was never worth $32 billion. He was always worth zero.
Buff Parham:
Well, and the problem is that crypto doesn't fit all of the criteria being called a currency in the sense you can't transact with it. Maybe if the store has of value, but you can transact with it.
David Edwards:
Well, you can't transact with it, and it's not a store of value because it can disappear overnight.
Buff Parham:
Yeah.
David Edwards:
So anyway, I've told anybody who has a fantasy that somehow it will all come back. I said, "No, just dump it at whatever price you can get and move on."
Buff Parham:
Well, compared to the rest of our shark jumpers, Trump seems like an old movie at this point. You think his power's peaked, and what will that mean to the GOP in the country in general?
David Edwards:
Yeah, that guy has more lives than any cat you could ever imagine.
Buff Parham:
It seems that way.
David Edwards:
But you know what? I don't feel like talking about the guy anymore.
Buff Parham:
Right. Exactly.
David Edwards:
I think my one comment was, here he is not only running for president and the most exciting announcement he could come up with was a bunch of shitty cartoon cards that he hawked for 4 ½ million dollars.
Buff Parham:
That's jumping the shark.
David Edwards:
That's definitely jumping the shark. I think what he needs to worry about is the response of this guy who was one of the January 6th insurrectionists who tweeted, "Oh my gosh, I'm going to jail for a NFT salesperson?"
Buff Parham:
By the way, the images of those NFT cards were stolen.
David Edwards:
Of course, they were, because Trump only hires the best illustrators!
Buff Parham:
Cut and paste, right?
David Edwards:
Before we go on, let me make one more comment about Trump.
He is running for the presidency again. It's not inconceivable he would win the nomination. Right now, Republicans like DeSantis, Cruz, Rubio and Graham are trying to decide whether they should hold off another four years or jump in now. Certain polls have DeSantis way on top of Trump, but we're still two years out. I can think of many other Republican governors like Jeb Bush from Florida, Scott Walker from Wisconsin, Chris Christie from New Jersey, who had a “lock on the nomination” and it never happened. The thing that will hold DeSantis back is that he's just mean, nobody likes him. He won a pretty sizable victory in Florida against pretty much no competition.
Buff Parham:
Yeah.
David Edwards:
I don't know how DeSantis will have pass a going forward. So it could be Trump in 2024. It could be DeSantis, it could be somebody else. It seems like Biden is going to announce he's going to run for a second term. Do you remember those happy days when you'd tune into the presidential election about three months before it happened?
Buff Parham:
One more thing is not highly noted, but the Republican primaries are winner-take-all and the Democratic primaries are proportional. So you can win a Republican primary with a plurality as opposed to majority.
David Edwards:
Yep. That is exactly how Trump won last time around He won maybe 35 or 40% of each primary, but it was enough to win the nomination
Buff Parham:
Winner take all.
David Edwards:
Back when Trump was new and interesting and nobody quite understood how many lawsuits and criminal indictments he would pile up in the next four years, including four more today.
I don't know what's going to happen two years from now. It's a little concerning. Now, it'd be nice to know that the government is in good hands. I feel like it is right now because things are sane.
Buff Parham:
We love normal. Well, are you ready for the pièce de résistance?
David Edwards:
Sure.
Buff Parham:
You have to give us five key predictions for the coming year, and this is being recorded.
David Edwards:
So predictions by people like me are fun to look at in hindsight. This time last year, I predicted that the S&P 500 would be up 4-6% by the end of 2022
Buff Parham:
There you have it?
David Edwards:
Oh, I'm wrong by about 24%. Right now, the SP is down 18% on the year. What's interesting is that the Russell 1000 growth component with Facebooks and Apples and Amazons is down 29%, but the value component is only down 10%. Actually, IBM is up 18% this year. Interesting. What that means is that growth and value stocks go in and out of favor over time. There's about a four-year stretch where growth was the style that won, but then value had its comeback year. Even so, now that I was so wrong on the S&P 500 for this year, I'm going to boldly say the S&P 500 will go up 15% next year.
Buff Parham:
Wow.
David Edwards:
The reason why I say that is because we follow a certain model, the Morningstar Fair Market Value model that's reasonably predictive over time. Right now, it's 15% undervalued.
Buff Parham:
Okay.
David Edwards:
Then on top of that, corporate earnings, while a little bit off the peak that we saw the start of the year are still coming in at 7-8%. So you've got a boost from earnings, you've got a boost from being undervalued, that pushes the stock market higher. Then in interest rates, I think we're close to the end of the raise for interest rates. I think the Fed has another one or two, maybe three raises left in them, take it anothe1%, 1 ¼%r higher and then stop. Well, that takes us to the level of interest rates that prevailed from 2000 to 2008 when the economy did just fine, so that will help. The stock market this year was held down by those rising rates. With these increases in the rear view mirror and earnings rising, the stock market should go up. Inflation I feel by the end of 2023 will be back down to 4%.
It's going to take a while longer to get back to 3% and 2% because now people are accustomed to raising prices for their products and people are accustomed for asking for bigger raises. IF people DON’T get those raises, they just jump to a different job. By the way, people can easily change jobs because unemployment is still down around 3.5%, which is a multi-generational low.
My last forecast is about recession. Every economist you can imagine has been beating the drum all fall about the horrible impending recession that's coming down the pipeline. I'm like, "Show me the data that says we have a recession going on," because normally one of the first clues about an incoming recession is a sharply rising unemployment rate. It's been flatlined the whole year. Oh, by the way, there's two job openings for every one person looking for a job right now. Oh, by the way, because of some of the Biden Administration legislation, we are bringing high-powered jobs back to the United States. For example, 10,000 jobs in Arizona to make chips.
Buff Parham:
Yep.
David Edwards:
Right? What did we learn from the COVID pandemic? When your chips are being made in Taiwan and you got to get them across the ocean, a lot could go wrong.
Buff Parham:
Yep.
David Edwards:
So let's bring some of that high tech manufacturing back to the back to the United States. Oh, you know what else is interesting. The most recent GDP report was 2.9%, not negative. You need negative GDP to be talking about recession. It was 2.9%. That was a higher rate of growth compared to the entire Trump Administration. Really? So we have no data that says “recession.” think we'll skate right by that recession next year, inflation comes down, stock market goes up, we're in pretty good shape.
Let me close on one other topic. It's been a pretty awful year for the stock market. It's been a pretty awful year for the bond market. You add the two together, classic 60% stock, 40% bond portfolio, it's been the worst year since 1937 during the Great Depression. But it did not harm our clients because our strategy says, "First off, put half your money in growth stocks, half of your money in value stocks."
Sometimes growth wins while value loses, sometimes the opposite. Over time, returns from either sector will average out. In the last four years, our growth stocks outperformed value. We sold growth and bought value to keep the overall allocation constant. This year we benefited. Even though the FAANG stocks were down 43%, our portfolios were down nothing like that. On the bond side, normally when stocks are coming down, bonds are coming up. This year, both stocks and bonds declined. All right, well that's the bad news. The good news is, we were getting extremely low yields on our bonds two years ago, like under 2%. Well, now that bond prices have fallen, yields have gone up. So now we're getting 4 1/2%, 5%. We're actually getting paid to own bonds for the first time since 2008. But meanwhile, the other thing that we always have in our mind is that these kind of bear markets happen frequently, every five years on average. We don't remember, but they do.
There was one 2 years ago in March to May 2020. It was over so fast, no one remembers it at all. But also 2008-2009, 2000-2002, 1987, every five years on average. Well, when we design a portfolio to support someone's draw, we always have a certain amount of money in cash, about a year's worth, and another four year’s worth of money in bonds and then the rest is in stocks. Normally stocks grow faster than bonds or cash. We pour the excess of the stock portfolio into the bond portfolio, from the bond portfolio to the cash portfolio, and then each month we send a check. But when stocks perform badly, we just turn off the waterfall between the stocks and bonds, wait a year or a year-and-a-half until stocks recover and then turn the waterfall back on again. In a terrible year for stocks AND a terrible year for bonds, not one client experienced a reduction in their monthly draw because of market volatility. Delivering that reliable draw is what we do - that is our job.
Buff, do you have any final thoughts?
Buff Parham:
No. I think you covered it wonderfully.
David Edwards:
You mentioned that your family is coming around for Christmas?
Buff Parham:
They're coming down and I can't wait to see everybody.
David Edwards:
Terrific. We are going the other way. We're going to go visit my parents, hang out with my sisters for Christmas Eve dinner. So on that basis, I wish you a Merry Christmas, Happy Hanukkah, and a Happy New Year.
Buff Parham:
Same to you and yours. Thank you, David.
David Edwards:
Good night.
David Edwards is president and wealth advisor with Heron Wealth, a $500 million registered investment advisor based in New York City working with 225 client families across the U.S. and around the world.
At time of publication, Edwards and/or his clients held positions Amazon, Apple and Google.