"Hope is being able to see that there is light despite all of the darkness." --Desmond Tutu
This continues to be a poor year in the global financial markets. Making matters worse, the places where we have historically sought safety and principal preservation, namely bonds, have had their worst year in decades.
Despite the seemingly unrelenting tsunami of negativity, we cannot lose sight of the fact that, in the not-too distant future, with the benefit of hindsight, many of us will likely be looking back on these days and saying to ourselves: “I wish I had invested more then.”
The price of equities, as measured by price to earnings, has declined dramatically from the beginning of the year. Forward PE for the S&P 500 ended last quarter at 15.1, which is below its long-term historical average of about 17. This probably represents a good long-term buying opportunity, but it is also likely that we will see prices go lower in the short-term before the official bottom of this bear market is reached, given the likelihood of a looming 2023 recession whose severity and duration cannot be known at this time.
On average, bear markets since the 1920s last 20 months with a drawdown of between -35% and -40% for the S&P 500. The current bear market, as measured by the S&P 500, has lasted about 9 months and reached a roughly -27% drawdown (session low reached on 10/13/2022). The market has already largely priced in some sort of an economic recession. Still, nobody should be surprised if we see lower prices over the coming months.
Value and high dividend stocks have been markedly better performers this year and we think we will continue to benefit from maintaining oversize exposure to them in investment portfolios. Additionally, US small and mid-cap value stocks look more attractive than large and growth stocks based upon relative valuation from historic averages.
Non-U.S. dollar assets have been particularly hard-hit this year as the U.S. dollar is at historic highs. One might imagine overweighting this asset class but given the poor European economic outlook and seemingly bleak winter just around the corner, it may yet be too early.
The consensus is that the current recession will be relatively mild by historical standards and come to an end sometime in 2023. Everyone also seems in agreement that the stock market can only bottom once the Federal Reserve clearly signals an end to rate increases.
But the stock market hates consensus and loves to do its own thing. In fact, the market often bottoms 3-6 months ahead of improving economic and corporate fundamentals, as has happened in March of 2009 and several other bottoms. This is another reason why trying to time the market is always so exceedingly difficult.
Yesterday’s (10/13/2022) market session is a good example of this. Inflation news were worse than expected and the market was poised for another tumble. Then, inexplicably, the market turned around and put in the best one-day rally in several years. The S&P 500 ended the day up +2.6% and the Dow Jones Industrial Average ended the day more than +800 points higher. Was yesterday the bottom? Nobody knows and only time will tell.
Looking forward to the final quarter of 2022 and 2023, our plan remains to stick to our process and look to buy high quality assets at the lowest possible prices. From a tactical standpoint, we will look to increase exposure to the U.S. stocks on another 5%-7% drop. At the same time, we may also start to extend the duration of our bond holdings. Finally, cycle throughs are typically a good time to consider high-yield credit, which is already more attractive than it has been for some time.
As always, we have much to be thankful for. We remain firm believers that, in time, our patience, discipline, and positive outlook will lead to positive results.
Sources: Stockcharts.com, JPM Q4 Guide to the Markets