2022 has been a rough year thus far for both stocks and bonds. To recap, the S&P 500 started the year around 4800 and fell to the June lows of 3636, posting a -24.5% loss. From there, a rally ensued taking the index up nearly 19% to 4325 in August on Peak Inflation/Peak Fed Hawkishness “expectations” but that rally has been met with a brutal 27 session selling stampede and we are now back to the June Lows. The Barclays Bond Aggregate fell -13.5% into June, rallied for a bit and is now down over -15% for the year as interest rates have shot up. Traditional 30-Year Mortgage Rates have more than doubled and are now over 6%!
If you have been reading my newsletters, you know that I have been cautious of the bond markets since rates went to zero and the stock market since early February of this year. We raised cash to significant levels, shortened our fixed income duration and focused primarily on defensive positions in low volatility equities such as utilities and consumer staples coupled with a hedged strategy in an effort to mitigate risk. They say if you want to catch a wave, you’ve got to grab a board and get in the water so when the data appeared to be “getting better” and markets became “oversold”, we’ve made attempts to put our cash back to work. Both of those “wave attempts” saw a rally but were ultimately ill fated resulting in those positions being closed shortly thereafter with little to no damage to our portfolios.
Two weeks ago, we received negative CPI (inflation) data which caused me to act once again in closing out positions and reinstating extremely high cash positions (20-30%) across our managed portfolios and last week’s price action around the FOMC meeting reiterated that was an appropriate action. Given the recent bout of volatility and selling, the big questions on everyone’s mind are 1) How Bad Can It Get? and 2) When Will It Stop? In an effort to overly simplify things, here’s my take:
- Historically, we have seen earnings multiples during recessions around 15x times expected earnings. 2023 expected earnings currently reside around $240 per share based on the S&P500 but most analyst feel that’s too high. Using history as a guide, the average annual earnings growth rate of the S&P 500 was about 11% before all the governmental intervention. Using 2019 as a benchmark and applying that same 11% growth rate would take earnings to $211/share. So, $211 x 15 would give us a “How bad can it get” number around S&P 3165. That’s about -14% below where the S&P currently resides. Please understand that I am in no way implying that is where we are heading, I’m simply saying that if things don’t begin to improve fundamentally and earnings come down along with poor investor sentiment, history says it can get worse…
- Current “Drivers” of the markets are:
- Inflation- We need to see CPI drop! While we are seeing prices ease in a number of areas such as industrial metals, food commodities and crude oil, housing remains elevated and that makes up nearly 40% of the CPI calculation. Real Estate sales are slowing, and mortgage applications have all but stopped so maybe this input is beginning to moderate…
- Fed Pivot- The Federal reserve has held its position on “Whatever it takes” to crush inflation. They are still telegraphing the need to see economic pain to bring this metric down. Employment has remained extremely resilient despite their efforts (raising rates and withdrawing liquidity) but how will they react should the economy begin to falter? In the past, the tough talk comes to an end when economic pain is felt. If CPI begins to come down and the Fed becomes more “Dovish” the market could take off like a rocket ship!
- Geopolitical Tensions- De-escalation of the Russia-Ukraine war would go a long way towards easing tensions and improving sentiment, especially in Europe.
- Earnings- Concerns over corporate earnings are pressuring stocks. The ridiculously strong US dollar is a major problem with the US Fed being the most Hawkish central bank on the planet, however, almost every other central bank raised rates along with the fed last week and the consumer continues spending. A positive earnings season could help pave the way to a soft landing and show GDP growth. If this were coupled with inflation coming down, a more dovish Fed and easing war tensions, new all-time highs (30+% gains) would not be out of the question in the foreseeable future.
That’s the fundamental story in a nutshell Folks! Now for the fun part. I’ve been managing money professionally for well over two decades and have been a student of the markets for much longer. What I’ve come to recognize over the years is that when ALL the news is negative and it just feels like it’s never going to end, something comes out and changes the sentiment. It’s often one piece of news at a critical support level in the markets that just changes the entire tone and from that point forward, things just get better. I have no idea what that will be or when it will happen (I ordered a crystal ball 20 years ago and it has yet to arrive), but I promise it’s coming, and I will be here waiting to act upon it.
For now, we remain in “Wait and See” mode and positioned very defensively. We have a lot of cash and cash alternatives on hand in our managed accounts to mitigate risk and redeploy when the current headwinds subside. It’s important to understand that what feels like forever has only been a 9-month reprieve and a lot of excess risk has already been taken out of the markets this year. I am confident opportunities for growth will present themselves in the near future.
Should you wish to discuss the current markets, our strategy, and the tools we use to manage risk or just touch base to see how things are going, please don’t hesitate to reach out to our office @ 843-651-2030. Also, feel free to share these newsletters with your friends and family via email and visit us on our website at www.sabowealth.com or www.facebook.com/sabowealth.
Important Disclosures: Past performance is not a guarantee of future results. The statements contained herein are solely based upon the opinions of Edward J. Sabo and the data available at the time of publication of this report, and there is no assurance that any predicted or implied results will actually occur. Information was obtained from third-party sources, which are believed to be reliable, but are not guaranteed as to their accuracy or completeness.