Market Commentary Fourth Quarter 2022

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Human civilization is a relatively recent episode if compared to the origins of the universe some 15 billion¹ years ago or the formation of our solar system 5 billion² years ago. And while modern humans (homo sapiens) appeared 550,000 to 750,000 years³ ago, the first complex human culture did not emerge for another 500,000 years—arising in Mesopotamia in western Asia about 6,000 years ago.

Recent milestones in human creativity include the Wright brothers completing the first powered flight of a heavier-than-air aircraft in 1903,⁴ the nuclear bomb in the 1940s, IBM’s own Personal Computer in 1981,⁵ the internet in 1983,⁶ the Apple iPhone in 2007,⁷ and the first Tesla in 2008.⁸ Do you get the sense that the pace of life-altering discovery is accelerating? I do. That’s why I’m always looking for the next innovation that will change our lives—and offer the potential for an attractive investment.

NASA’s Artemis mission is a potential source of innovation. Artemis is working to return humans to the moon’s surface by the late 2020s.⁹ NASA says, “The lunar surface will serve as a crucial training ground and technology demonstration test site where we will prepare for future human missions to Mars and other destinations.”¹⁰ This is not science fiction; NASA plans to begin crewed missions to Mars in the 2030s.¹¹

The space program has long been a source of innovation. Think of advances like digital imaging applied to medical diagnostic tools like MRI and CT scans, as well as smartphone cameras, portable computers, solar power, and materials created for safety in space.¹² Exploration of our moon also has the potential to help ease climate change and improve sustainability due to the discovery of an abundant supply of hydrogen-rich molecules in the moon’s southern hemisphere.¹³ If that supply can be mined, its first use might be to produce rocket fuel, and beyond that, to bring climate-friendly hydrogen fusion to Earth, reducing the need to burn fossil fuels.

The sophisticated technology required for an initiative like the Artemis mission makes me think about the need for access to effective STEM education at both the high school and college level. The shortage of STEM skills has resulted in a dearth of qualified applicants for technical positions in science and technology, and it is estimated that by 2030 nearly 85 million jobs will not be filled due to the lack of skilled workers.¹⁴

On a different note, if you own or plan to buy real estate, you’re probably wondering what will happen in 2023 if higher interest rates continue. House price growth is decelerating across the U.S.,¹⁵ but a dramatic drop in housing prices like that of the 2008–2009 global financial crisis is unlikely. There are negatives, such as banks cutting back on risk in multiple ways. However, mortgage holders are in good positions, with some 90% locked in at rates under 6%.¹⁶ Most mortgage holders have equity in their houses, the housing supply is constrained, and it appears that the labor shortage of around 3.5 million people ¹⁷ will limit the scale of layoffs (see left-hand side of graph below). As Fortune magazine tweeted, “Even if home prices did crash 20%, it shouldn’t cause a 2008-style financial crisis nor a foreclosure crisis. The Pandemic Housing Boom’s 40% run-up was simply so high and fast that a 20% decline wouldn’t put that many borrowers underwater.”¹⁸ We don’t foresee a massive wave of foreclosures.

The difference this time, is illustrated by Lawrence Yun’s chart, which compares the “Last Housing Cycle” of 2008 to the “Current Housing Cycle” of 2022.¹⁹ Yun notes that while there have been layoffs in the mortgage and technology industries, due to job creation in other parts of the economy, the overall workforce’s net gains and losses are slightly positive.

Early during the fourth quarter, we took additional profits in oil and gas companies in anticipation of softening prices. Last quarter, we noted that the Fed can’t directly affect oil prices. However, the federal government managed to dampen prices by easing sanctions on Venezuela.²⁰ In November, Chevron received a federal license to resume oil production in Venezuela. Ten years ago, Venezuela produced 2.9 million barrels a day; it now produces less than 700,000 barrels a day. Venezuela also holds the world’s largest crude oil reserves; the country has more than 300 billion barrels—more than Saudi Arabia. The impact of increased Venezuelan production is potentially great.²¹

Venezuelan oil is a plus for fighting inflation, but not all changes in the world support inflation reduction. China’s abandonment of its zero-COVID policy may be a mixed blessing. As the Chinese economy rebounds, it could boost prices for the raw materials that go into Chinese-manufactured goods. On the other hand, the rebound could help tamp down the inflation caused by shortages of the goods China produces.

This quarter, we added to the fixed income allocation as part of our approach to risk management. Bonds appeared particularly attractive because bond prices have fallen significantly in response to the Federal Reserve’s interest rate hikes. For now, we’re “clipping coupons,” but we anticipate that prices will rise as inflation moderates.

In other purchases, anticipating the progress of NASA’s Artemis mission, we bought into a company that appears positioned to benefit, and we’re looking at other companies that might benefit upstream or downstream from Artemis.

As always, thank you for the trust you have placed in me and in 7Summit Advisors. We work hard to earn that trust each day.

Sincerely yours,

Li Chang