Our volatility indicators are still negative and the market is clearly very volatile. Both the tech heavy NASDAQ and Russell 2000 small cap index entered bear market territory yesterday. By definition a bear market is when prices fall 20% or more. I was watching CNBC yesterday and one of the talking heads made a comment about how terrible things have gotten, and it reminded me of the of the proverb “markets bottom on bad news”.
One word of caution: as we saw yesterday, a few good up days do not reverse a downtrend. Let the our volatility signals clearly turn positive before buying, stay disciplined, and wait until the trend turns back up. There are a lot of very attractive opportunities that have gotten crushed over the last few weeks, such as Salesforce, AMD, Meta/Facebook, NVIDA, and the list keeps getting longer. When the market does rips back up, we will be looking at a lot of great companies that have sold off. As I have mentioned before, we have built up a very healthy sleeve of cash and will hopefully be able to take advantage of a lot of bargain buys.
You can expect a volatile market for the next few weeks to months, but it should turn up by before or by Summer. Until our signals turn positive, sit tight and be patient.
For the first time in a long time, the S&P 500 is trading below what I think “Fair Value” is for stocks based on our monthly Market Expectations Table, but while that gives us some additional comfort that this 4,300-ish-4,600 trading range can likely hold, this market remains at risk of a further substantial decline if the current market influences “get worse” and the magnitude of that decline is easily 10% (likely more). What that means practically is that while there is value in this market given the current situation, there’s still plenty of reasons to be cautious.
Looking at the March Market Expectations Table, there are two new influences compared to the February update: The Russia/Ukraine war and oil prices. The reason these are included this month is clear, as the war in Ukraine is sending oil prices (and most commodities) screaming higher. That’s putting upward pressure on inflation and a head-wind on growth (which is raising stagflation risks) while the Fed is hiking rates and about to start Quantitative Tightening. The other two market influences, Fed Tightening and Inflation, remain largely unchanged and that makes sense because there wasn’t much “new” revealed on either front from February until now. But that’s going to change starting Thursday as we get the latest CPI report, and again on March 16 via the Fed.
Current Situation. The Current Situation for this market clearly isn’t great, as risk assets are facing headwinds from geopolitics, oil, the Fed and inflation. At the same time, the S&P 500 is down 11.9% YTD, so most of the currently challenged outlook is priced in at these levels. Specifically, markets are pricing in continued geopolitical unrest, high oil prices, a Fed that will be somewhat aggressively removing accommodation, and high inflation. Given that set up, it’s not surprising stocks are down YTD.
But this environment itself isn’t enough to warrant a materially more defensive positioning than we currently are, because in its current form the headwinds on the economy aren’t likely enough to cause a recession or a material drop in corporate profits. For that to happen, we’d need to see further deterioration, and that’s why we can say that the S&P 500 does have some value to it at these levels, again assuming the macro influences don’t get any worse (which obviously is unknown).
Things Get Better If: There is a truce between Russia/Ukraine and Russian troops withdraw, oil drops back towards and below $100/bbl, the Fed hints it won’t hike more than four times in 2022, and Inflation peaks. Sentiment has become quite negative on the market, so if we get positive surprises from these four market influences we could be in for a solid relief rally of 5% or more. However, we are still going to be in an environment of high inflation and rising rates, (neither are changing in the short-term regardless of Russia/Ukraine) so even if we get positive surprises over the coming months, the upside in stocks is still limited in the near term because the broad market multiple can’t be justified over 20X (and even 20X would be a stretch, fundamentally speaking). Bottom line, this market is poised for a bounce on legitimately good news (so one or more of the above events) but returns will be limited.
Things Get Worse If: The Russia/Ukraine war continues for several more weeks, oil stays near $120/bbl or goes higher, the Fed hints there could be more than five rate hikes in 2022, inflation does not peak. From a market standpoint the key variable in the Russia/Ukraine war has always been time. The longer it goes on, the worse it is for the economy and the markets. If this conflict rages for several more weeks that will only increase the chances of a global recession in the coming months. If the conflict carries on for several more weeks, oil would likely stay near current levels (around $120) or move higher, which would be an additional headwind on the U.S. economy broadly and consumer spending and corporate margins more specifically. Finally, with oil that high, it’s unlikely inflation would peak in the near term, which would keep the Fed hawkish despite the risks to economic growth. This scenario is essentially that everything that’s pushed markets lower YTD only gets worse. In this environment (which would move quickly towards stagflation amidst geopolitical uncertainty) the market multiple would drop sharply to between 17X-18X, and that means this market could easily fall more than 10% from current levels before it hit what would be considered “fair value” for this macroeconomic environment.
Bottom Line
The March Market Multiple Table accurately reflects the current market reality: Based on events as they are now, there is value in the market at these levels. But if we see further deterioration in the macroeconomic influences driving this market, it’s still a long way down (more than 10%) before stocks can find solid fundamental footing.
So, the MMT reflects this reality: Markets are at a key inflection point. Markets have been hit by multiple negative macroeconomic blows that have sent the S&P 500 down 11.9% YTD. But if this is as bad as things get, stocks have a value component to them now. However, if things get worse, it opens the door to a much less optimistic set up, one driven by stagflation and rising rates. If that’s the case, we’re likely not even halfway done in this current market decline. Bottom line, we need to some good news and soon.
And remember – the one fact pertaining to all conditions is that they will change.
Best regards,
Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President
Direct: 952.828.5336
Email: kurt@ivoryhill.com
—Written 03.07.2022.