Bear Market Rally Or New Bull Market? 😰 2022-2023 Recession
This is the question on everyone's mind. So, let's try to discuss the facts... and the facts only. I'll tell you how I really feel towards the end.
Most of this discussion will be an update to my thoughts from my previous post on the 2022 recession.
What started this rally, really?
This rally (however you want to classify it) started from oversold conditions to an apparent "Fed pivot" coupled with stronger than expected Q2 earnings, and possibly "peak inflation". So, we'll talk about those things, which support the thesis of a new bull market, along with some technical analysis.
Did the Fed really pivot?
The obvious answer to this is, "no". Let me explain. The comment that likely got everyone riled up, was the use of the word "neutral".
We’re at—we’re at 2.25 to 2.5 [percent], and that’s right in the range of what we think is neutral. --CHAIR POWELL
They key concept in the "neutral" would be keeping inflation constant. OK... so, let's assume that Powell is right and we are at neutral here (i.e. instead of maybe another 50bp higher). But Powell followed that up with the fact that they are fully-committed to continue their fight against inflation.
So one thing that hasn’t changed is that—won’t change—is that our focus is continuing to—is going to continue to be on using our tools to bring demand back into better balance with supply in order to bring inflation back down. That’ll continue to be our overarching focus. --CHAIR POWELL
So, let me ask you this... do you think inflation will just come down on its own from here? If you say "yes", that is suggesting that 100% of the inflation that is around today is "transitory" (the forbidden word by the Fed). It's clear there are SO many inconsistencies in that logic, imo.
Bear Market Rally: We haven't yet landed
Does peak inflation necessarily mean a Fed pivot? Well, it depends on what their goals are... but, more importantly, how quickly they want to get there. Based on their latest projections, they feel PCE and Core PCE will reach a median of 2.7 and 2.6% (respectively) YoY in 2023.
We should get PCE readings next week, which should display significant cooling... after its latest reading of 6.8% and core of 4.8% in June. The core PCE is what we should really be interested in.
In any case, let's again assume that inflation has peaked, does that mean the Fed reverses course? Using history as a benchmark, you'll see that the Fed has in fact cut rates in several instances, prior to inflation peaking. You can see this below in 1975, 1990 and 2008....
But guess what else is common? 1975 = recession. 1990 = recession. 2008 = recession. In order to believe that the Fed will pivot on inflation peaking alone, you're still subscribing to the theory that "this time is different" or this time they'll achieve the infamous "soft landing".
Is a soft landing possible?
My honest opinion is no. 0% chance of soft landing.
But, without bias, let's look at when this was done in the past.
1964-66 this was done with inflation at 2% and unemployment at 6%.
1983-84 this was done with inflation at 5% and unemployment at 10%. This is more impressive off these two metrics alone, but the Fed funds rate was above 8%. This is obviously not possible today!
1994-95 this was done with inflation at 2%. Again, no comparison to the 8.5% we still have today.
I still believe there's no precedent for a soft landing that the markets are pricing in today.
New Bull Market. Who dis?
The bulls, who are clearly in control of the market right now... are pricing in a 100% chance of a soft landing, split near 50/50 on next FOMC decision between 50bp and 75bp, and with the Fed cutting rates next year. Although I agree with the latter two, I don't believe with the first point (as you already know). There is zero pricing in of an earnings compression.
There's one thing I can't contest... and that is the technical strength. If you can use technicals effectively, it allows you to remove a key element which typically works against your favor in investing... emotion. So, I don't fully discount technicals even when investing in individual stocks.
The technicals are suggesting we're in a NEW bull market.
Like I said, I can't argue this... my personal opinions and biases are removed from this conclusion. The S&P is now above every moving average, except the 200 day SMA. It's closed above the 50% Fib retracement which was a key level I was looking at. Aside from the 200MA being taken, the only thing left (from a technical standpoint) is the 50/200MA "golden cross".
Whether we've seen the bottom, or not... there's CLEARLY a lot of strength here.
With, the exception of volume. Although volume has been strong during the initial rally, and still is... it's been declining. Which suggests, the rally may be on it's last legs. But, that doesn't necessarily mean we go back to the lows.
Have we hit THE bottom?
Going off the technical strength, there are few instances where we've gone lower after retracing 50% from the bottom. That's what the bulls are using to go all-in from here. I find that very risky... and quite frankly scary. Why?
The bear markets that have seen a 50% retracement (or more), have been the longest & worst bear markets in history – including, more recently 2000 and 2008. Here is a great thread pointing out the different occasions, with charts.
I won't use (alone) this to say the worst is yet to come, and that we're in for a long ride... but let's assume that this is THE bottom, and this was more of growth scare like 2006. What is the market pricing in terms of growth?
S&P forward earnings growth
At the moment, the markets are pricing in a forward P/E of the S&P at 18.1, which represents S&P earnings of $238... which would be 16% earnings growth YoY – which is the median growth rate since 1990.
Looking at historic growth rates, we had -77% earnings decline in 2008 and -50% in 2000. I'm not saying we go there, but the only chance we have at taming inflation is with some sort of slowdown. Going from 55% to 12% is definitely a slowdown that is priced in. But, it's one (again) with a soft landing.
I previously talked about 1948-49 as a potential benchmark to inflation coming down on it's own without too much Fed intervention. But that inflation was driven mostly by supply issues. Which, I don't think I can say anymore. Seeing equity markets rally the way they have recently, leads me to believe there is still lots of liquidity in the system that needs to be removed.
Other negative catalyst still on the horizon
The European energy crisis, Ukraine war, and Chinese economy that are the biggest looming ones, imo. The global economy is not strong right now, and there is a lot of geopolitical uncertainties. Though these have always existed before, and I don't want to sound doom and gloom. We kind of just have to learn to live with some of these imo.
Previously, I did believe a recession was inevitable. It was just a matter of how quick/deep. We're technically in one, but does it end here, or is this just the beginning? Initially I believed we would be able to get away with a quick one, but I don't think we have seen any real demand destruction just yet. The natural rate of unemployment would be too high here (though there are significant weaknesses therein, like the lower participation rate and double jobs), and the inflation rate is still too high.
The path is clear... a deeper recession or a higher benchmark inflation rate. The reality is, we're near the end of this long-term debt cycle. The only way to sustain it further is with higher inflation. I don't know which direction policy will take, but I would wait for further clarity.
What Stocks To Buy?
I am going to be going adding to growth sectors that have secular tailwinds, like cloud and cybersecurity. However, I will be extremely patient in adding, as I believe the time horizon to add will over be the next year.
I will be going short or hedged, if I see overextended conditions – like we are today.
I will be looking for a real "Fed pivot" and not a fake one. The Fed minutes this week will be EXTREMELY important to comb through.
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