“The truth is sometimes a poor competitor in the marketplace of ideas—complicated, unsatisfying, full of dilemmas, always vulnerable to misinterpretation and abuse.” – George F. Kennan
Well, it certainly seems like we are in the thick of it, doesn’t it? If one of the more difficult transitions of Fed policy in response to rampant inflation weren’t enough, now it appears that the largest army assembled in Europe for many decades is about to unleash a potentially vicious invasion. As rates continue to rise in anticipation of tightening, so does the discount rate for stocks. Stocks that have a high proportion of future earnings comprising their net present value are particularly vulnerable. This is part of why high-flying stocks with poor results or guidance fell so hard this season. Geo-political events over the past century have tended to be non-events if you invest on a long enough time horizon for the most part, but when events affect, or may potentially affect, energy
supplies the results seem to be worse. Our Head of Research, Tom Lee, will give you some specific stats on the market reactions to recent invasions.
Sentiment has reached very low levels. Forward guidance has dropped considerably more this quarter than last quarter. Economists have also been curtailing growth forecasts moderately. However, there are also signs in the data that some of the hawkish hysteria may be overdone. This point is even more poignant when you consider the different “wants and needs” of the bond market versus the stock market. Tom Lee will elaborate on this use below.
Despite the rise of hawkish hysteria, we are beginning to see some signs that inflationary forces may be subsiding. The New York Fed found inflation expectations, a leading indicator decreased for the first time in over a year. Three-year inflation expectations declined from 4% in December to 3.5% last month, which is a significant drop. Furthermore, the base effects are going to start working against higher numbers. Delays are decreasing at Long Beach and the Port of Los Angeles.
Also please remember this, despite all the legitimate reasons for fear around the removal of central bank accommodation Bank of America found that there were positive returns for equities in the first year following interest rate hikes the last six times rates were raised by the Fed. It is understandable why markets are so apprehensive, but saying “this time is different,” is always dangerous in investing. If you’re going to say it, have some very good data explaining why.
The BoA Fund Managers survey found that fund managers are the most underwight technology stocks since August 2006. Their levels of cash are also at the highest since early in the pandemic. Uncertainty is high now, but it’s not as high as at the beginning of the pandemic. We knew this half would be choppy, we didn’t anticipate quite how quickly it would come on.
On the positive side of news, which may seem scarce these days, ethics rules were passed to significantly curtail trading activities at the Fed and among judges. ARK Innovation’s Cathie Wood was interviewed on CNBC and despite steep losses in her flagship funds holdings, she is sticking her to exponential growth thesis and says on a long time horizon this is a buying opportunity.
Our Head of Technical Strategy, Mark Newton, has reason to believe that we should bottom before February ends. We are maintaining our bullish outlook for the second half of 2022 even though that position is becoming less consensus. The news is very positive on COVID despite surges in Asia, and the trend seems to be in favor of rolling back restrictions rather than the other way around. So, while it may be a consternating and difficult time to look at the screen please do consider making a shopping list of high-quality stocks that have advantageous entry points. There are reasons to be optimistic and some sentiment indicators are giving extreme readings. There is no doubt though that this is a trying time for markets and anytime costs of capital are affected in a significant way it will effect high P/E stocks more than low P/E stocks. Real economy stocks performing better like Energy, Financials and Tobacco. No need to be a hero and call bottoms. Increased participation in derivatives markets can sometimes make ‘catching a falling knife’ more like catching a falling bus.
