Stocks consolidated yesterday and for much of this week. Following a 14% bounce higher in the S&P and a 17% pop in the growthier Nasdaq over a 5-week period, this is to be expected. Resistance levels are approaching where sellers typically emerge. While earnings are a bit better than expected, forward guidance is, at best, muted. This has clearly been a P/E expansion rally; one built upon lower interest rates and an expectation that the Fed is nearing an end to this tightening cycle. The future looks brighter than many feared but it is still quite cloudy near-term.
A soft-landing, minor recession scenario is becoming a base case, a far cry from an expected, elongated recession everyone was fearful for in June. Although we have been impressed by the resiliency of corporate America, there is much work to be done on the inflation front. The next few months of data will be critical in determining if this bear market is indeed over.
Brief “summer rallies” are typical and much ado about nothing. Pundits will push the narrative but these months are not any better than average at best. There is not much volume, especially during the July-August time frame as vacations arrive. When they do come back, it can bring forth increased volatility. What matters more is the starting point. In June, stocks were beaten up and very oversold. Retail investors and investment advisors were overly bearish; even more than April 2000 following Covid closures. When there is that much bearishness, usually the selling process has already been completed and short bets are pressed. A move higher brings short covering and the bulls take charge, for now.
Incoming data has improved, albeit from one of the worst levels in decades. Price pressures are starting to moderate. Commodities, including the all-important energy component, have dropped. Average gasoline prices are down for 50 consecutive days. Shipments and ports are nearing normalcy and delivery times approach pre-pandemic levels. Businesses are becoming more comfortable with their inventory levels (excluding low-end retail and autos). The job market is loosening a bit, finding an equilibrium that helps wages but not by too much to stoke inflation higher. Home prices have started to ease, which will eventually bring buyers back to the market. In that vein, mortgage rates just had the largest monthly drop since 2008. While we have recorded 2 negative GDP quarters, the NBER (the official determinant of if/when a recession starts) considers 6 variables: real personal income, nonfarm payroll employment, household survey employment, industrial production, real sales and real consumer spending. Politics aside, these indicators are not negative enough. Combined, it is not even sniffing a recession.
All of the above adds up to a not-so-bearish environment, hence a relief rally. FOMO (Fear of Missing Out) takes over, adding fuel to the fire. In fact, Meme stocks are back in vogue again as well, handily outperforming the markets lately. FANGMAN stocks also took over, as investors jumped back in to old favorites. From the June lows, that group of mega-cap tech leaders are up 27%. This strength requires increased attention. Thrusts, such as we’ve just witnessed are rare. In June, only 5% of the S&P 500 were in uptrends. Today it is over 75%. Previous thrusts like this showed long-term gains every time though none of those periods had 9% inflation and a tightening Federal Reserve.
This brings us to today. What are investors to do now? The S&P, at one point down 25% from January, is now down ~12% for the year. This is a great time to review asset allocations. Interest rates are about as attractive as they have been in the past decade. A few years ago, it made sense to press the risk button and allocate towards higher equity levels in portfolios considering bonds were only offering 1% – 2% returns. Today, one can find many 5%, investment grade, corporate bonds readily available. In tax-free accounts, 3% – 4% is commonplace, also extremely attractive.
I can’t help but recall Mike Tyson’s famous quote, “everyone has a plan until they get punched in the mouth.” If the first half of 2022 brought forth extreme stress and personal fear while stocks crashed, it may be time to adjust risk exposure and evaluate your investment plan. Locking in 5% total returns in quality bonds is relatively attractive. If stocks get back to historical norms, one is giving up modest upside in return for less volatility (in normal conditions).
Bond returns just posted their worst performance in centuries during the first half of 2022. Going forward, we expect prices to stabilize and rate movement to not be as pronounced. We recommend buying debt backed by quality balance sheets and stable company business lines with growth. Further, expect to hold bonds until maturity, ensuring you get an annualized ~5% return on the corporate side. Daily prices may change, but bonds mature at par ($100). Focus on the safety and predictable income provided. As always, Nick Filippo and the Tower Bridge team are happy to review your investment portfolio if you wish.
On the equity side of markets, spikes are everywhere, especially in lower quality and the most beaten down areas. Now may be a good time to reassess long-term leadership abilities and what companies’ positions are for the future. Just last night we saw double digit gains in Fubo, Cloudflare, Yelp, DoorDash, Carvana and numerous other companies that have yet to produce a GAAP profit. Many mall-based retailers are up 25% – 50% in two months. Ditto for old line industrials. No earnings and high price-to-sales companies are up even more. Not all stocks are created equal and many of the bounces are in names that will never get back to old highs or even be around in a decade.
This bounce can also be an opportune time to do some tax loss harvesting too. Stocks went straight up for three years. Any sales placed earlier in 2022 likely created a capital gain. After the malaise through June, it is probable that some stocks are sitting with losses. One can book those losses, which are not as bad as a month ago and put proceeds into higher quality, long-term themes we’ve been discussing: electrification, 5G, clean energy, autonomous everything, robotic factories, artificial intelligence…etc. Even if this is not “the” final bottom, investing in secular themes usually works out over time. As we’ve been noting, market timing is fruitless. Everyone who sold in June is now thinking they missed the boat.
Whether this is another bear market rally or the start of a brand-new bull markets remains to be seen. As noted, incoming data is still positive and inflation is expected to moderate. Corporate profits are holding up. Outlooks are for slower growth but positive nonetheless. Valuations are fair, if not low, depending on if interest rates keep dropping. China should be more productive with less Covid lockdowns into 2023 as they finally push for vaccines. The Russia/Ukraine conflict, hopefully, does not get worse. Outside of the low-end, consumers are still flush.
On the bearish side, yield curve inversions like what we have now, have always preceded a real recession. Timelines are 6 – 20 months away, but not encouraging. During slowdowns, earnings per share estimates come down 10% – 20%. That has not happened yet. Inflation may be peaking but if the Fed slows their rate hike cycle too early, they risk never getting back to 2% CPI. The strong US Dollar remains a headwind for most. Loans are getting harder to come by. There’s fuel for all sides of this debate still.
August jobs data is due out this morning and could move markets ahead of the weekend as well. A good, not great jobs update will work wonders for those wanting the Fed to slow its tightening schedule. Now that Senator Sinema got the carried interest tax loophole taken out of the bill, it looks like the Inflation Reduction Act will be passed. Stocks have already moved on that news.
Nibbling at the depths in June made sense. Tax loss harvesting and repositioning portfolios makes more sense today. The future is bright, even with uncertain economic clouds ahead in 2022. Still not an all-clear signal but quite a broad bounce back in economically sensitive names that benefit from lower inflation and lower interest rates.
Olympian, Lolo Jones, turns 40 today. Maureen McCormick, better known as Marcia Brady, is 66 today.
James Vogt, 610-260-2214