Grey Owl Capital's Q1 Letter

Dear Client,

In the first quarter of 2022, financial markets abruptly reversed course and volatility increased significantly. While new trends were already in place, the moves intensified when Russia invaded Ukraine on February 24th. It is probably hard to remember, but the S&P 500 was up 11.1% in the fourth quarter of 2021 and commodities (up 1.5%) were the worst performing of the major asset classes.

In an about-face, from January to March, commodities were up 32.4% and the S&P 500 was down 4.6%. Gold was up 5.7%, but “safe haven” US Treasury bonds were down 10.6%. Grey Owl’s All-Weather strategy finished the quarter down 4.4%. In comparison, a 60/40 benchmark was down 5.7%.[1]

In our last quarterly letter, we emphasized how narrow the US equity market had become beginning around mid-year 2021. We wrote that the narrowing “presaged the current market downturn and a likelihood that the downturn continues for several months or quarters.” We maintain that perspective as the narrow market persisted (and intensified) through the first quarter. While the S&P 500 was down, it held up much better than small capitalization stocks (down 7.5%), technology stocks (down 8.8%), and innovative growth companies represented by the ARK Innovation fund (down 30%).[2]

The sell-off has accelerated through April. Through April 27th, the S&P 500 is down 7.6% for the month. The Nasdaq Composite and the ARK Innovation fund are worse: down 12.6% and 25.2% respectively. Throughout the month, Grey Owl’s All-Weather relative performance has continued to improve.

By late January, we had made significant adjustments to our model portfolio selling the majority of the more speculative (“reopening”) equity positions, raising cash, and increasing our exposure to “defensive” equities. Regrettably (at least for now), we also began to build positions in long-dated US Treasury bond ETFs.

The most unusual aspect of financial markets during the first three months of 2022 was the simultaneous sell-off in both equities and government bonds. Typically, US Treasury bonds perform well during equity market sell-offs. That has not been the case so far this cycle. Given the recent retrenchment in the price of oil and other leading indicators of inflation, we are optimistic that Treasury bonds have a high probability of positive performance going forward as economic growth, inflation, and corporate profits are all positioned for considerable deceleration.