The markets experienced a significant rebound in the month of July with the S&P 500 up 9.2% during the month and up a total of 12.8% from the June 16th low. Meanwhile, the fixed-income markets improved as well, as the Aggregate Bond Index was up 2.4% for the month. The media, market pundits, and other investors have been scrambling to develop a narrative that fits and justifies the bullish price action of stocks. Here are just some of the narratives gleaned from Twitter and CNBC over the last week or so:
In spite of the fact that the Fed and other government officials have been trying to sugarcoat the current economic slowdown and avoid calling for a recession, the Fed is actually looking at the recent economic data (which shows a severe and dramatic slowing of growth) and seems prepared to hit the pause button with respect to interest rate hikes. This reaction may be a signal that the economy is weakening faster than the Fed had anticipated. No matter whether you call it a recession or not, based upon historical precedent, this is not a bullish signal for the economy or for stocks.
Despite the various narratives to explain the recent market move, it is important to assess the current facts as they emerge. The US and Global equity markets have been under pressure in 2022 due to an overheated economy and rising inflation created by the massive global stimulus following the Covid pandemic, supply chain disruptions and related fallout from the war in Ukraine. Perhaps the market rebound in July was just a bounce from a severely oversold condition with extremely pessimistic investor sentiment. This type of price action is representative of a typical bear market rally that we have seen many times before in prior bear markets. The following chart demonstrates the current bear market compared to the bear markets from the “Tech Bubble” and the “Great Financial Crisis”.
It is important to note that bear markets associated with recessions tend to last longer than other bear markets. One can see that, in terms of duration, the current bear market in blue is still in the early phases, compared to the prior two instances. In addition, we can also see that there are many bear market bounces that have occurred historically, and this market move since June 16th represents the fourth such rally we have seen in just 7 months. Bottomline, forget the narratives, stay patient, stick with a disciplined and risk-managed investment approach, and focus on the long-term.
Back to the last Fed meeting…as noted, the market and pundits interpreted the outcome of that meeting and the decision to withhold guidance on further rate increases as bullish for stocks, but, importantly, the prior Fed interest rate hikes had already jumpstarted the economic slowing process. For sure, the recent Fed meeting has changed the outlook and expectations for future rate hikes as can be seen in the chart below, with the expected number of rate hikes falling from 7.23 to 3.62.
The economic data which was so effusively positive a year ago has made a quick reversal due to the dampening effects of the rate hikes and the nearly insurmountable growth comparisons from a year ago when the world was emerging from Covid restrictions. That being said, we are seeing most of the data demonstrating a slowing economy, particularly among the consumer, where high inflation, higher interest rates, and the end of Covid stimulus are beginning to take a toll. Remember that consumer spending represents two-thirds of US GDP. With the Personal Saving Rate hitting its lowest level since 2009 and Revolving Consumer Credit hitting all-time highs, that should make it difficult for the consumer to pick up the economic slack. See the two charts below:
In terms of manufacturing data, the recent US ISM Manufacturing report has indicated one of the most significant slowdowns in the last 50 years. The headline ISM print of 52.8 slowed for the fifth straight month, a typical slowing heading into a recession, while ISM New Orders slowed to a 27 month low and ISM Inventories accelerated to its highest level in 38 years. With the Fed tightening into this news/data flow, it’s not hard to rationalize why they may be pumping the brakes for the time being.
Finally, with respect to the current credit conditions, we are seeing tightening credit conditions and data that is also indicative of slowing economic growth. The yield curve has become inverted, meaning that 2-year bonds are yielding more than 10-year bonds. Short-term bonds are guided by the Fed policy, while the longer-term bonds are typically guided by investor’s expectation for growth (or contraction) in the economy and inflation expectations. So, an inverted yield curve typically is a signal that economic growth is slowing. In addition, liquidity is coming out of the financial system. This is evident in the contraction of bank deposit liabilities and the widening of corporate credit spreads. See the charts below.
While most of us know that the stock market is a leading indicator of both good and bad news, we need to keep in mind that bear markets associated with economic recessions take time to play out. Furthermore, the bottoming process itself takes time as well, usually 6 to 9 months. Just look at the time it took to form the bottom from the Tech Bubble crash from July 2002 to April 2003 or the bottom from the “Great Financial Crisis” from October 2008 to June 2009.
By the end of June, the markets had already experienced a 20% draw down in the S&P 500, roughly two-thirds of the average bear market. So, while we could see a retracement or pullback of the recent price move and potentially more downside, a good chunk of the downside has already occurred, compared to historical averages. Furthermore, with higher inventories and less stress on the supply chain, we have been seeing early signs of relief in the inflation cycle. If we continue to see further contraction in economic growth and inflation begin to trickle down over the coming months, we should see longer-term rates come down and bond prices begin to recoup some of the downside that was experienced in the first half of the year. This reflects the importance of a balanced portfolio, where the bonds can help protect the total portfolio from any additional downside that we might experience in the equity market.
What we witnessed in July is most likely a typical bear market rally, forged by stocks bouncing off of extreme oversold conditions and short-sellers being forced to cover, fueling the rally. However, keep in mind the following: 1) the time that it takes to work through the process of a bear market and recession and 2) the importance of patience and discipline during this process. We are not suggesting anything other than not to chase the narrative and not to chase stocks into rallies at the early stage of this economic slowdown. It is easy to get caught up in FOMO – the fear of missing out.
As always, we believe that the best investment results are achieved by taking a long-term focus. Our goal is not to try to predict the market, but rather to develop risk-managed investment plans that can weather the difficult times. Maintaining discipline, patience, and an objective investment approach is the best way to meet the long-term objectives of our clients.
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The statements contained herein are based upon the opinions of Bison Wealth, LLC (Bison) and the data available at the time of publication and are subject to change at any time without notice. This communication does not constitute investment advice and is for informational purposes only, is not intended to meet the objectives or suitability requirements of any specific individual or account, and does not provide a guarantee that the investment objective of any model will be met. An investor should assess his/ her own investment needs based on his/her own financial circumstances and investment objectives. Neither the information nor any opinions expressed herein should be construed as a solicitation or a recommendation by Bison or its affiliates to buy or sell any securities or investments or hire any specific manager. Bison prepared this Update utilizing information from a variety of sources that it believes to be reliable. It is important to remember that there are risks inherent in any investment and that there is no assurance that any investment, asset class, style or index will provide positive performance over time. Diversification and strategic asset allocation do not guarantee a profit or protect against a loss in a declining markets. Past performance is not a guarantee of future results. All investments are subject to risk, including the loss of principal.
Index definitions: “U.S. Large Cap” represented by the S&P 500 Index. “U.S. Small Cap” represented by the S&P 600 Index. “International” represented by the MSCI Europe, Australasia, Far East (EAFE) Net Return Index. “Emerging” represented by the MSCI Emerging Markets Net Return Index. “U.S. Aggregate” represented by the Bloomberg U.S. Aggregate Bond Index. “Treasuries” represented by the Bloomberg U.S. Treasury Bond Index. “Short Term Bond” represented by the Bloomberg 1-5 year gov/credit Index. “U.S. High Yield” represented by the Bloomberg U.S. Corporate High Yield Index. “Real Estate” represented by the Dow Jones REIT Index. “Gold” represented by the LBMA Gold Price Index. “Bitcoin” represented by the Bitcoin Galaxy Index.