In a CNBC interview yesterday morning, a less than enthused David Tepper, one of the greatest investors of all time, along with a dour semiconductor outlook from Micron’s latest earnings disaster, and the start of a blackout period for stock buy backs put an end to the much-anticipated Santa Claus rally. Tepper’s comments are consistent with what Jim and I have been saying for months. In short, valuations are not as cheap as normally occurs at the end of most bear markets, interest rates are going to be higher for longer, the Fed will not halt their aggressive actions until they are assured of victory on inflation. The globally driven central bank quantitative tightening phase is sure to bring more pain to select areas of the economy over the coming year. This does not change Tepper’s (or our) enthusiasm for the U.S. stock market over the long haul, but this tightening period is not over. The next few months are critical to the depths of any upcoming recession. Central banks around the globe have never tightened this much, this fast and in a coordinated effort. They will succeed in lowering inflation. In the meantime, values are becoming apparent in select areas, while other growth stocks may have more room to fall before they become cheap enough for investors to become aggressive buyers.
Granted, a lot of this negative outlook is already reflected in today’s stock prices. World class industry leaders like Amazon#, Tesla (lost another 9% yesterday and down ~50% since Musk bought Twitter), Meta#, Nvidia, Adobe#, Square, Salesforce#, Google#, and even Disney# are down over 40% this year. These are real businesses that have seen their stocks decimated. Some of that is due to the over valuation achieved when interest rates were zero and money was falling from helicopters. However, a large part of their decline is pricing in a significant slowdown in business operations, revenues, margins and earnings for 2023. Bad news has a way of hitting stock prices well before negative headlines. Still, much of the market is trading at 16X forward earnings. That is cheap relative to the past decade where interest rates were sub 2%, but certainly not cheap relative to history when interest rates are ~5%. Adjustments are still being made, making risk/reward today a tough near-term proposition. Recall from previous updates though, every bear market does end and it creates another new, larger bull market. Long-term entry points are arriving, even if the near-term headlines are likely to get worse.
Year-End Market Calls
The end of every calendar year brings forth prognostications on what to expect for markets in the upcoming year. Most of Wall Street is usually positive, almost to a fault. This makes some sense as the market historically rises more than it declines. However, during bear markets, these forecasters have a tough time adjusting. Take last year’s predictions for 2022. Of traditional money management firms, Oppenheimer and BMO were the most bullish, calling for 5,300 on the S&P 500. Morgan Stanley was one of the least bullish, calling for 4,400. It looks like we will end the year sub-3,800. Not great!
Here is what is being predicted this time around for the S&P 500 at the end of 2023:
• Deutsche Bank 4500
• Oppenheimer 4400
• BMO 4300
• JPMorgan 4200
• Jefferies 4200
• Wells 4200
• Evercore 4150
• RBC 4100
• Credit Suisse 4050
• Goldman Sachs 4000
• HSBC 4000
• Citi 4000
• BofA 4000
• UBS 3900
• Morgan Stanley 3900
• Barclays 3725
• SocGen 3650
• BNP Paribas 3400
That is an 1,100-point range with a drop of 13% to a gain of 15%. As you can tell, we recommend taking these with a huge grain of salt. No one has a crystal ball that can predict where the major averages will finish on a consistent basis.
Here is what we do know and can develop a “base” plan for 2023:
• Inflation has peaked but is still quite elevated relative to history and the Federal Reserve has a lot of work to do before inflation is under control.
• The Fed is clearly focused onbringing inflation down to 2% today. This could change over time, but any change would be because the jobs market collapses, the economy enters a deeper recession or another Black Swan Event. They will not let up if GDP is positive, jobs are plentiful and inflation is still over 4%. The bull case hinges on inflation rapidly falling and the Fed easing their tightening measures quickly.
• This means higher interest rates are here to stay for the short to medium time frame, especially relative to the past decade.
• Higher interest rates directly correlate to lower P/E multiples. 17x forward earnings is not “cheap” by any historical precedent.
• The consumer still has savings left to spend and most are generating higher income than pre-Covid. If/when inflation gets back to a normal range, the consumer will see an increase in spending power.
• However, we have to get to that point without corporations wielding massive layoffs in 2023. This only works if the jobs market has its own soft landing.
• Bonds now offer a real alternative to stocks. When one can lock in 5% – 6% in high quality corporate bonds for several years of income, it makes a lot of sense relative to the volatility in stocks.
• What you own is more important that just buying indexes. Energy, consumer staples and utility stocks generated positive returns this year (or close to). So did several commodities like silver. Gold is rallying to finish flat on the year. Cash and T-Bills also had positive returns in 2022.
US Federal Spending Bill:
Another massive Omnibus Spending Bill, estimated at $1.7 trillion, was agreed to at the Senate level, and with it, plenty of added pork. The national debt has exploded during Covid to over $32 trillion. This new bill will not help one bit in controlling spending or the interest payments associated with our bubbling deficit. With our Central Bank fighting inflation, our government continues to spend money like it is free, counter to what the Fed is working on. This is and has always been how DC operates. You scratch my back (and get me voted in) and I return the favor. While there is nothing wrong with helping our friends, some of these spending items are controversial:
• There is $2.3 million to inform the public about President Biden’s student loan cancellation program, which is on hold pending Supreme Court review and likely to not even be legal.
• $410 million goes towards border security…in Jordan, Lebanon, Eqypt, Tunisia and Oman.
• $1.4 billion to organizations like the United Nations.
• $3 million for “bee-friendly” highways.
• Another $45 billion for Ukraine bringing that tally towards $100 billion.
• Millions in Senator-named museums, highways and various platforms.
There are many other items in the 4,155-page document recently given to the Congress that are highly unlikely to be read or fully understood by their teams. Granted, a lot of this spending is going in the correct places; bringing more diversity where needed, helping those in distress and improving the infrastructure of the United States. Not all pork is bad…even if one side of the aisle is doing the complaining this time around.
Tower Bridge Advisors would like to wish everyone a Happy Holiday!! Markets are closed on Monday in observation of Christmas.
Finn Wolfhard, of Stranger Things fame, is 20 today. One of my favorites, Eddie Vedder, turns 58. During our first trip with the young children to New York city, they fully remember the Naked Cowboy, who turns 52 today.
James Vogt, 610-260-2214