Key Takeaways
  • The S&P 500 closed at 3,825.33. The VIX fell 7% on Friday after a market turnaround and closed at $26.70.
  • On Thursday, the beleaguered S&P 500 capped June as its worst month since March 2020. By most accounts, we haven't seen this kind of persistence in pessimism since March 2009.
  • We offer a few reminders for navigating such challenging markets and keeping a clear mind during such times.

Good Evening:

In times of uncertainty, Abraham Lincoln quoted lines from Shakespeare’s Hamlet. “There’s a divinity that shapes our ends, / Rough-hew them how we will.” Hamlet is acknowledging that there are many things outside of his control. The point is that much of life, and markets, is shaped by chance and accident, which is why it’s a good idea to not always have fixed plans. Lincoln would later elaborate with this analogy that he used to explain his course on Reconstruction: “The pilots on our Western rivers steer from point to point as they call it—setting the course of the boat no farther than they can see; and that is all I propose to myself in this great problem.”

What Lincoln was implying: Amid the turbulence of the Civil War, and with much out of his control, his best approach was to focus on the few things over which he did have power, namely his temperament, messaging, and decision making. The former president probably would have liked how the novelist and playwright E.L. Doctorow thought about steering his course on writing: “Writing is like driving at night in the fog. You can only see as far as your headlights, but you can make the whole trip that way.”

It isn’t all that different with challenging markets: Steer from point to point, from week to week—particularly in times of great uncertainty. There’s no telling how much more stocks will fall, especially as the Federal Reserve maintains its most hawkish stance in decades, with the goal of taming 41-year-high inflation. Nobody knows for certain where markets will end the year. But we can see the gift of this opportunity.

While long bear markets leave most investors with limited options, they also present time to rebalance and tinker with strategies. Time to practice remaining calm and humble. Time to practice not panicking or compromising our health. For longer-term investors, the best option in these markets is often to do nothing but take long walks, learn, study, and catch up on your reading, a sentiment recently shared by legendary investors such as Stanley Druckenmiller and Warren Buffett. Those guys have made a few bucks. They know a thing or two.

Remember, the stock market will bottom before the economic data gets better. And remember, sometimes patience is the best action, as our Brian Rauscher, Head of Global Portfolio Strategy and Asset Allocation, has reiterated in recent months. “There’s no need to be a hero,” our Tom Lee also has said. We might be in a bottoming process this month. We might not bottom for three or four months. Or we might grind lower through the end of the year, mired in a recession, and not see sustainable market gains until sometime next year.

Markets Rally Hard on Friday, All Sectors Green
Source: NYT

Three of our research heads remain bearish in the short run. Rauscher, who turned from bullish to bearish in March, said Thursday in our weekly meeting that markets could bleed lower for three, six or even nine months given the Fed and inflation, as well as negative earnings and forward guidance. “My work continues to weaken,” Rauscher said.

Mark Newton, our Head of Technical Strategy, remains long-term bullish but said July likely will be marked by continued downward chop. “Bottom line: We need inflation numbers to cool off before we move higher,” Newton said. His work shows the market could bottom in late July, which would fall in the heart of big-tech earnings reports.

Adam Gould, Head of Quantitative Strategy, reiterated his view that the market remains overvalued based on his models, and the upcoming earnings season will be “very, very important.”

Earnings

  • Nike opened earnings season with respectable numbers on both the top and bottom line, especially when considering the sizable economic tailwinds and China lockdowns. Yet the stock sold off more than 6% on an earnings beat, which might be a harbinger of what’s to come in July, Rauscher said.
  • Restoration Hardware, a pandemic darling that rose more than eight-fold from March 2020 to May 2021, has been battered thanks to a slashed forecast for the second time in less than a month, soaring mortgage rates, and shrinking sales of luxury homes. Rauscher, whose work is rooted in earnings revisions, notes that his models show the estimates will continue to fall sharply, driving stock prices lower. “It’s not pretty,” Rauscher said of his outlook this summer.
  • Key earnings dates to watch include Apple, Microsoft, Alphabet, and Tesla, which all report later this month.

Bear Market Rallies

The beleaguered S&P 500 closed another week lower, capping its worst month since March 2020, and capping its worst first half since 1970. It’s worth noting that this statistic, which has circulated widely, is misleading. The S&P 500 happened to hit its all-time high on Jan. 3, the first trading day this year, and equities are still just 21% off their highs. (The carnage in the Nasdaq is worse, at about -30%.) If the bear market ended June 17, 23.4% off the high, this would go down as one of the least-bearish bear markets on record. At times, it has been a snoozer, with the VIX staying below 34 all year, a rarity for a bear market.

That said, other than this year, the only time in the last quarter century that both stocks and bonds were down in back-to-back quarters was 2008. Even still, we’ve seen a few traditional bear market rallies this year, including last week.

Consider: During the Great Financial Crisis, amid max pessimism, there were several strong rallies, including ones of 15%, 18%, and 24% — that’s not a typo – before plummeting to a bottom in March 2009. All told, we’re about six months into this downtrend, which is the 13th decline of 20% or more since WWII.

Markets Rally Hard on Friday, All Sectors Green
Source: A Wealth of Common Sense

Of course, things could get worse, especially if inflation persists. Consider that:

  • Since World War II, inflation above 5% has preceded a recession every time
  • Ten of the past 13 recessions have followed a Fed tightening cycle
  1. Every time oil prices have doubled relative to the prior two-year average ($54 in this case), a recession has occurred
  2. Taken together, the Fed seems to be aggressively tightening into an already-slowing economy
  3. Some companies are laying off workers. However, most layoffs are coming in the Technology sector, particularly among companies that over-hired during the pandemic
  4. Bitcoin, trading at about $19,000, just completed its worst month in its young history:
Markets Rally Hard on Friday, All Sectors Green

Lessons from the National Pastime

You don’t need to swing that much in this game, especially if you’re uncertain of what’s next. Warren Buffett took an important ingredient of his investment strategy from baseball Hall of Famer Ted Williams, who wrote The Science of Hitting. Williams argues that to become a great hitter, you must keep yourself from swinging at bad pitches – what you’re looking for is the perfect pitch in your wheelhouse. Buffett took the analogy to investing: You can stand at the plate all day waiting for the right opportunities. “You don’t have to make any decisions,” Buffett once said. “Nothing is forced upon you. They might be wonderful pitches to swing at, but if you don’t know enough, you don’t have to swing.”

As we depart for the holiday weekend, we leave you with a final thought from Oaktree Capital’s Howard Marks: “Almost all the great investors I know are unemotional. Unemotionalism is one of the most important criteria for being a successful investor.” 

Wishing you and your family a restful Independence Day weekend of health and happiness,

-FSInsight Team

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