It’s officially time to change the status of the market from “it’s complicated” to “bear”. After seven straight weeks of relentless selling, the S&P surrendered on May 20th dipping into bear-market territory (a 20% decline from its recent high). The selling intensified following huge missed earnings by retail bellwethers, Walmart and Target, which brought into question the spending health of the consumer. That’s actually the good news compared to the tech-heavy Nasdaq that is off to its worst start to a year on record. The Nasdaq notched an intermonth low of approximately 30% from its previous high last November. With the proverbial sky falling and bearish sentiment at extreme levels, the market was ripe for a bear market rally. Almost on cue, the markets climbed up 6% — the best weekly gain since November 2020. This illustrates the difficulty of navigating bear markets as volatility comes not only on the downside, but with like whiplash on the upside rallies as well.
Inflation – “Highway to the danger zone”
There were a few bright spots this past May. High on the list was the long-awaited release of Maverick, the sequel to the 1986 blockbuster, Top Gun. Firstly, it was great to be back in a full movie theater again! As I sat back in my chair, I couldn’t help but think that the 80’s are making a resurgence in the world we live in today. Politically, the most evident resurgence is that of the Cold War. This time, however, the proxy war is being fought in Ukraine instead of Afghanistan. The mass exodus of corporate America (McDonalds, Facebook & Netflix) from Russia is undoing decades of globalization. Economically, it’s 80s déjà vu with the rise of record inflation that has sparked fears of stagflation and crippling interest rate increases. Although we are nowhere near the 1981 peak Fed funds of 20%, the relative path from zero to 2.5% seems daunting. Fed Chairman Powell basically warned us of a potential upcoming recession this May when he said he couldn’t promise a so-called soft landing for the economy. As I said in my previous article, and it’s worth repeating;
In the short-term, the Fed, unfortunately, isn’t our friend. Like most patients, the market isn’t liking the taste of Chairman Powell’s medicine, but we’ll be thanking him later when the symptoms ease and things begin to normalize. Here’s the simplest way to put it… “short-term pain for long-term gain”.
As long-term investors, it’s inevitable that you’ll have to navigate a few recessions or, yes, even a “crash” from decade to decade. In investing, as with most things in life, there is no free lunch. So, volatility is the price we investors pay for the rewards of real (inflation adjusted) returns in the long run. When volatility spikes and markets enter bear market territory, this is what Maverick would refer to as a “target-rich environment” with numerous buying opportunities presenting themselves. Let us be reminded of the challenging times in the 80s with peak inflation at 14.8% and prime interest rate at 21.5%, the Cold War, two recessions respectively spanning one year and ten months, Black Monday with the DJIA crashing 22.6% — the largest single-day stock market decline in history, an energy crisis caused by the Iran-Iraq War. What was the end result of this decade of chaos and big hair? Drum roll…the S&P returned 389.2% (227.4% price appreciation & 161.8% in dividends). Just like the original Maverick, the squeal is well worth the price of admission which, in case your curious, is $13.69 vs $3.71 back in 1986. This is another reminder of the importance of investing to keep hold of your purchasing power.
QE to QT – Quantitative easing to Quantitative tightening explained
Since the financial crisis of 2008, all the world has really known and become addicted to is Quantitative easing (QE). QE, according to Wikipedia, is a monetary policy whereby a central bank purchases financial assets to inject money into the economy to expand economic activity. It’s normally seen as an unconventional or drastic measure, but for the last fourteen years, it’s been part of the everyday monetary conversation. Reason being, once you’re “hooked” on easy money, it’s really hard to kick the habit. Up until recently, global central banks have had the cover of low inflation or even deflationary fears to keep money flowing. Fast forward to 2022, the Fed balance sheet sits at $8.9 Trillion and record inflation is forcing Powell’s hand to raise interest rates and reduce its bond holdings starting with $95 billion a month reductions beginning this June. These actions are defined as Quantitative tightening (QT) were central banks sell financial assets which in itself can move rates higher and have a slowing effect on the economy. Although QE has had its effect on increasing inflation, I believe that COVID-19 supply chain issues, Ukraine war and China lockdowns are the main culprits and that is, sadly, out of the Fed’s control. I do believe that the combination of QT and supply chain easing will be more than enough to bring inflation back under control by the end of the year. It is already clear what damage QT signaling and hot inflation data points have had on the stock market year-to-date. The true economic softening will lag in the data as it always does, but it’s already appearing on earnings calls with CEO’s and companies are acting appropriately. Tech companies that not long ago were fighting each other to hire are starting to freeze hiring or even lay off workers. This includes Facebook, Tesla (10% cut of workforce), Netflix, Google and Coinbase to name a few. Companies will have no choice but to tighten their belts as they try to deal with higher costs and slowing demand. The question becomes how much of this negative cycle is priced into the stock market? Can a contrarian view be made that the Fed is acting appropriately and will thread the needle into a soft or slightly bumpy landing? Could softening economic data points alleviate inflation fears and lead to a market rally? Can the almighty consumer shoulder the burden of higher rates and keep a recession at bay? As a value-oriented portfolio manager, I see this period not so much as the “sky is falling”, but more as the continued return to normalcy were fundamentals matter.
Behind the numbers – 06/29/2022
One extremely important data point was released just one day ahead of schedule on May 29th 2022. My baby niece Laila Sax was born, weighing in at a lovable 5lbs 15oz. She is of course gorgeous and adorable all at the same time. As a very proud Godfather, I feel it’s my duty to boast about her cuteness. It’s also a personal reminder that each of us are most likely investing for those we care about most, our families. Cheers to the next generation!