One of the oldest investment axioms for market experts is to never set a price target and attach a date to when it happens. The market is a humbling beast that delights in making the supposed “smart money” look foolish. Anyone who is arrogant in the investment business is either too new or about to be colossally wrong.
Yet as a portfolio manager of equity funds, I must have a market view. Quite simply, the concept of “just pick stocks and ignore the noise” sounds great in theory. However, too much of a stock’s return is explained by macro inputs to simply put on blinders regarding the market. The painful unwind of the uber growth stocks over the past six months has had far less to do with stock specific problems and a lot more to do with a massively shifting macro environment that is no longer willing to stomach sky high valuations.
With that prelude, and 36 years of the market consistently reminding me of my place in its world, what follows is my best guess for the remainder of 2022.
Overall, I remain cautious as we head into the summer, yet optimistic about a rally from the expected summer market lows through the end of the year.
- Regarding my cautious stance heading into the summer:
- In my opinion, we have not yet hit maximum growth scare hyperbole (“recession coming, look out below”).
Here are some of the maximum growth scare signals we are watching for:
- VIX >40…. not there yet.
- GS Financial Conditions Index tighten to over 100…. not there yet.
- Put/call ratio reflecting extreme investor anxiety…. building.
- High yield spreads to Treasuries blowing out…. not there yet.
- Fund flows turn very negative…. not there yet.
- CTA trend-followers have all but given up on equities…. in process.
- Typically, with this level of volatility in bonds, currencies and stocks, something breaks. Hedge fund blow-up? Debt default? Who knows?
- I think a maximum growth scare will happen when the Fed actually begins the more aggressive rate increases.
- I do suspect we are nearing a short-term bottom for the market:
- Stock buybacks are collectively the number one buyer of stocks. The window for stock buybacks will largely reopen, having been closed for much of April.
- Corporate fundamentals in the Q1 earnings season, overall, were simply too strong to scare off the bulls.
- Investor optimism is very low, and that is a contrarian indicator.
- With increased expectations of a hawkish Fed, investors could positively react to any more balanced-stance signal from Powell.
- The annual lows during a mid-term year have pretty consistently arrived in the summer.
- I continue to believe 4,050 is an attractive initial entry point for the S&P 500 and 3,850 is a distinct possibility.
- Regarding being optimistic following a potential summer low and a buyer at that level:
- Corporate and individual balance sheets remain too strong for us to experience more than a growth “scare”.
- We do expect inflation to subside.
- Therefore, Wall Street is likely to, yet again, overestimate the degree of Fed tightening.
- If inflation subsides as recession fears fade, the setup for an equity market rally exists. However, at this juncture, it’s premature to expect more than an oversold bounce.
- During a mid-term year, Q4 has historically been the best quarter, as the incumbent party refocuses on “stimulus” (passing out the candy) in front of the upcoming Presidential campaign.
- While the full year S&P 500 return could be lackluster from the 4,778 level on January 1st, 2022, the upside potential from those targeted lows would be quite attractive.
- Yet, sadly, here is what I am highly confident will occur:
Investors cumulatively won’t be buyers into a summer low. Instead, they will hit the panic button to sell at exactly the wrong time.
- Here are our current thoughts regarding portfolio positioning:
- It’s too late to buy defensives. The time to buy defensives is when the market is soaring and nobody wants them, as happened at the end of 2021.
- Our portfolios have been underweight growth stocks. That is changing, given the magnitude of growth underperformance relative to the market.
- Therefore, using defensive positions as a source of funds, we are actively preparing a list of quality growth stocks to potentially add into this next leg lower for the market, with the following characteristics:
- phenomenal long-term track records of profitability outpacing their peers.
- no fundamental problems in their businesses.
- down over 20%+ from their highs.
- reasonable (do not have to be cheap) valuations.
- While now is too early to pull the trigger, we do think that a great opportunity is nearing.