Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio and Technical Strategy.
The news seems to increasingly worsen (i.e. currency volatility, sharply higher bond yields, Nordstream pipeline leak, etc.), as is often the case during bear markets. And this impacts human emotion, as long-term investors get sucked into the short-term uncertainty and volatility. On the positive side, this is the type of reaction often seen closer to the end of a bear market- as investor psychology shifts from fear to panic and ultimately capitulation. In fact, the AAII investor sentiment survey shows the highest percentage of bears since March 2009 (lows of the credit crisis). We believe we are in the fear/panic phase currently, which suggests further downside in the near-term (weeks to months). However, we also believe we could be 3/4ths of the way through this bear market cycle.
We believe high inflation will take time to moderate, and volatility in the data is likely to correlate with volatile markets. Additionally, all of the Fed tightening will work with a lag on the economy- ultimately putting downward pressure on inflation, but also increasing the likelihood of economic contraction. This will weigh on corporate earnings ahead, and current estimates need to be revised markedly lower in our view. High yield credit default swaps, which have been a good indicator on market trends this year, broke out to new highs this week- suggesting further downside.
However, the question is how much is already priced in? Recessionary bear markets have historically contracted 33% on average over a 13-month span. We are already down 24% over 9 months. Timing an absolute bottom is extremely difficult when uncertainty and volatility runs high. The index often capitulates at the bottom, reaching a low in sharp fashion for a very quick period, with very rapid recoveries. On average, the S&P 500 is up 16% in the first 30 days of a recessionary bear market bottom- while the news is still very troubling. In a worst case scenario, we believe the S&P 500 could reach 3000-3200. This would be in line with the Covid low P/E of ~14x (from roughly 17x currently), but the index is oversold enough to bounce at any time. Economic data (specifically as it relates to inflation trends) is likely to remain the big influence. August PCE is reported tomorrow, September ISM Manufacturing on Monday, JOLTS Job Openings Tuesday, September ISM Services Wednesday, and the September jobs report (with wage growth) next Friday.
In sum: While it is easy to become increasingly more short-sighted in volatile periods, we remind investors that a lot of negative news has already been priced in at current levels. High inflation is an issue, but leading indicators suggest it should improve- the timing and degree are the unknowns. Equities likely still contain downside in the short-term (weeks to months), but don’t lose sight of the long-term bull market opportunity on the other side of the current weak trend. Bull markets go up 152% on average and last for years.
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