Bear markets can be damaging, but they eventually end and result in significant investor opportunities, explains Thomas Samuelson, CFA, CMT, Chief Investment Officer of Vineyard Global Advisors, a risk-managed, separate account manager.
Vineyard Global Advisors’ investor webinar, themed The Bear Market Arrives - Why and What’s Next, included a deep dive into the challenging first half of the year and thoughts regarding the firm’s expectations for the remainder of the year.
Key takeaways regarding economic trends that impact investors and how best to gear up for change include:
While 2021 was not the norm, it was a perfect “bullish storm.” The U.S. was poised on the cusp of a solid economic recovery, resulting in a huge 70% rebound in earnings that was supercharged by $10 trillion of government spending. All in all, signs pointed to an excellent year for investors, but we were skeptical that it would continue given Fed actions. It was not a typical year. 2021 was wonderful indeed – until it wasn’t.
The bull market investors enjoyed since the pandemic crash in the spring of 2020 ended this year. The first half of this year was the worst decline we’ve seen in the stock market since 1970, and bonds provided no relief as they had their worst first half in over a century.
Inflation Soared to Multi-Decade HighsThe massive stimulus caught up with inflation last year and caused it to soar, with the previous month’s CPI report hitting an annual rate of 9.1%, the highest since 1981. To be sure, the Ukraine war has also contributed to inflation pressures, but prices began rising well before the February start of the war. They’ve increased almost every month from only a 1.4% annual rate at the beginning of last year.
The massive stimulus also caused a tech bubble. The Fed threw another $5.2 trillion into the U.S. economy, which found its way into assets of all kinds, including FAANG+ stocks, which drove their valuation to over 70 times earnings at their 2021 peak. After falling 33% this year on average, they are selling for 31 times earnings – half their peak level but arguably not cheap. Moreover, the Fed likely will shrink its balance sheet into next year or extract money from the economy, which may continue to weigh on some of these stocks along with other more speculative young, unprofitable tech companies, which lost close to 80% over the past 12-18 months.
How low can we go? Vineyard predicts inflation will be mild for several reasons. These include the fact that consumer balance sheets are in good shape, business balance sheets are also in good shape, the job market remains strong with twice the job openings vs. unemployed, and inventories are low for many items.
The bottom line is that we are likely in the seventh inning of the bear market with 10-18% further downside possible. Accordingly, Vineyard Global Advisors remains defensively positioned and is waiting for indicator improvement to adjust exposures more aggressively. Investors should monitor bull case catalysts, including indicator improvement, downside breadth divergences, and bullish breadth thrusts. The burden of proof is on the bull case.
The next domino to fall will likely be earnings disappointments. We remain in a bear market, and at this point, the central “arrow in the quiver” of the continuing bear case rests on the increasing risk of recession and the likelihood that analyst earnings estimates will need to come down. Stocks typically react poorly to negative earnings momentum, and earnings typically fall 5% during a non-recessionary slowdown and 20% during a recession.
“What is frankly mystifying to us is the fact that despite all the deteriorating macro data, the analyst community still expects full-year 2022 earnings to increase 6% from last year and has increased its earnings estimates 0.2% since the beginning of the year. History suggests they are behind the curve, will have to play catch-up very soon, and will need to cut their estimates,” Samuelson said.
Significant opportunities await investors in sectors such as US small-cap stocks, energy, basic materials (especially copper), and re-valued secular growth names in 5G, artificial intelligence, cloud computing, and electric vehicles.
“VGA strategies participated strongly in last year’s bull market and are navigating this year’s bear market well. As a result, we think the potential for a significant buying opportunity is strong. After last year’s bull market, we will have less of a hole to dig out of before getting back to making money when the bear market ends, which has already paid rewards over this market cycle,” Samuelson concluded.
View the Full Q2 Webinar Replay Here...
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Investment advisory services offered through Integrated Advisors Network, LLC (“Integrated), a registered investment advisor. Vineyard Global Advisors is a DBA of Integrated.
