I wrote two articles this week. Really to test out an idea, playing out one side of an argument and seeing how convincing it is. Then I set it aside and wrote this one.
This one . . .
This.
Pessimistic.
One.
Because as much as I hate to think it, or say it.
I think the market’s going lower.
It’s palpable, or at least it’s beginning to be. Fear.
You can sense it, on social media, which is part communication network part thermometer. People are worried because it’s starting to slide, and when the market slides, and rallies fail, then the furrows really set in. Especially when people throw up charts like these.
That my friends would be the S&P 500 Index today overlayed with the index during the Great Financial Crisis. Eerie to say the least. Is it though? Because isn’t this all about sentiment (i.e., human nature)?
Well maybe not entirely about sentiment. I mean look at inflation. CPI headline numbers were 8.3% for the month. That figure hit like Thor’s hammer earlier this week and jolted everyone out of their summer stupor.
Let’s repeat, interest rates cover investors for two things, risk of loss and inflation. If inflation runs higher, then interest rates will be higher. Interest rates are gravity and when gravity increases, prices come down. Even Ray Dalio from Bridgewater repeated the mantra in an article this week, and the market was . . . surprised?
This is how it is? Really?
Yes, this is the way.
Just look at how interest rates reacted after the 8.3% print.
The front of that curve leapt higher as it reset expectations for how aggressively the Fed would hike interest rates. Any notion that the Fed could begin to taper rates were shelved. Inflation is still an issue, and interest rates need to go higher to cover for it (per the market) and to quell it (per the Fed).
What’s notable though is it’s not just the 3 month or 1 year front instruments that are moving higher, even the 10 year and longer-dated instruments are getting dragged along. By year-end, the 1-2 year T-notes will likely yield more than 4%. If so, how does the stock market compete at today’s levels?
It’s understandable when there is no alternative (“TINA”). When investing in a risk free Treasury bill/note yields less than 1%, sure put it into the stock market. We’ve written about TINA before, and she’s a lot of fun at the liquidity parties . . .
. . . but after the party ends and the sun rises, TINA sure looks a bit . . . tore-up, and FOMO?
He’s looking for his shoes.
Think about it another way. The S&P 500 is forecasted to earn $234/share next year (2023) (let’s just use Goldman’s figures for illustrative purposes). If so, what’s a fair multiple on that? At 3,845 today, the market is giving the S&P 500 a 16.5x multiple, or 6% earnings yield.
Yet, that’s a baseline, meaning $234 is assuming earnings grow from 2022 and there’s no recession. Yet this is what Fedex said on Thursday night.
He continues . . .
OMG . . . please stop talking . . . yikes. So think about that $234.
We’re in mid-September and a global delivery service is telling you things are slowing. Is $234 even achievable next year? What happens if it’s a 5-10% recession? What if earnings decline and S&P 500 generates $210? Now we’re going backwards. Slowing economy, lower sentiment, higher rates, and even more Quantitative Tightening (i.e., draining the bathwater from the global pool of liquidity) all portend that.
At $210 and today’s 3,845, we’re then looking at a 18.3x multiple, or an earnings yield of 5.4% vs. a risk free 1 or 2 year note of 4%. If so, why take the risk? See there is an alternative now. When TINA was YOLO-ing at <1% interest rates, it’s an easy call, you keep dancing to the music until the break of dawn. As dawn breaks though and we can see more clearly, there may just be better choices to be had.
So yes, we think markets are going to slide lower here. We’ve thought that for awhile, but it just took time. Remember this article we wrote a few months ago? Waiting to Cross. It was about why the market was rallying in the face of seemingly relentless inflation. It was about the MOAR GROWTH, DOOMSDAYERS, and STAGFLATIONIST crowds all waiting their turn to cross the street and influence the market.
Shouldn’t the market recognize that the factors for inflation were stickier and more persistent than what’s being priced in? You’d think, but the market shrugged it off and rallied much of the summer as the MOAR GROWTH crowd carried the sentiment and the market higher. Again, how does that make sense? It doesn’t and as inflation reared its head, it scared rates higher, and now at 4%, many are wondering why take market risk to garner a 5-6% earnings yield. Heck, that’s fundamentals, tack on the sentiment and they’re asking why take market risk at all.
If it is the DOOMSDAYERS’ turn to cross, then the market will become increasingly skittish as the voices of those peddling fear gets louder and more shrill. We’ll cross a rubicon of fear, when the initial reasons for a sell-off swing from fundamentals (i.e., inflation, interest rates, relative returns, lower global growth, the fading of TINA, bonds/stocks, etc.) to an emotional one (i.e., lower prices begetting lower prices because of fear).
So be very careful here. Be very rational in your decision making.
We’ve written about fear before, in the context of a major oil sell-off. Specifically, fear, uncertainty, and doubt (“FUD”) are all handmaidens in squirrelly times, and they can make you susceptible to questionable advice.
So you have to think clearly in these times, balancing the fundamental factors you know with the emotional ones that you know are coming. As DOOMSDAYERS cross now, it’ll get louder and scarier, simply because fear sells and it’s human nature to buy fear. Let the fundamentals guide you, knowing that the market sentiment can swing the volatility on you. If you can’t stomach the volatility then consider easing up on the positions.
The music’s changing now, and the lights are coming on. TINA is looking tired, and maybe there’re better choices to be made.
As for FOMO?
He’s still looking for his shoes.
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Let's say the comparison with 2008 is reasonable. That being said, there would be only 12.5% downside risk. Big deal! Seems that the most sensible strategy at this point is to average down across this last phase of the bear market rather than being caught by FOMO in a violent recovery.