At the beginning of the year, we wrote that investors should be cautious in 2022, that a strong economic backdrop should keep market declines contained. That looked like a good call after the first quarter, which saw swift declines in January and February reversed by a strong rally in March. However, the economic situation has deteriorated in recent months, and stock prices along with it.
There is much talk of a pending recession, with some pundits virtually certain that one is imminent. We are not in the business of forecasting recessions, and we urge investors to avoid thinking in binary terms. Economic data suggests that the economy will continue to slow in the 2nd half, whether that results in recession or not remains uncertain. The question we ask is “what is priced into the market, and is reality likely to be better or worse than that?” Our work shows us that corporate earnings expectations for the 2nd half of the year are likely too high for a slowing economy. If those earnings forecasts are revised down, stock prices would likely decline as well.
Similarly, our technical work shows us that the situation at the recent bottom in June is inconsistent with a major market bottom. There were some positive signs, such as the fact that more growth-oriented, risky stocks did not make a new low alongside the broader markets. We do think the bottoming process has begun, but after declines of this magnitude, more time is needed to form a sustainable bottom.
In sum, our process tells us that things may get worse before they get better. We have high levels of cash in most client portfolios for this reason. But, we remind investors that today’s issues are solvable. Higher interest rates, a slowing economy, and declining valuations will not last forever. We are not facing systemic issues in the global banking system.
Today’s problems should not deter long-term investors. At some point, perhaps this summer, we will reach a point of max pessimism where sellers have been exhausted and all bad news (real and perceived) has been priced into the market. After that point, experience shows us the market can rise much faster than people expect, even as news reports remain gloomy. Our process will not pinpoint this moment, but we strive to recognize it and react accordingly. In the meantime, we will continue to make any adjustments needed to tilt the accounts towards areas of strength. Better times lie ahead for those with the patience to weather the current storm.
