Since it’s been a one-way street negative market narrative during the recent sell-off, I thought it may be helpful to put down a list of positives and negatives on the economy and markets. Despite what some analysts will say, the stock market is not the economy in the sense that you can have big market sell-offs supposedly predicting a recession that never shows up (See Paul Samuelson). Markets are great at reflecting the mood/narrative of the moment and the current expectations of things to come. They’re not always correct. Think of them as reactive, not necessarily predictive.
With this context, I’ll say it’s almost impossible to be positive when S&P 500 is -22% since the start of the year. Let’s make the bear case as we’re in a bear market (-20%). (If you are already queasy, skip to the positives section.)
Here are the negatives.
- CPI at +10%
- PPI at +8%
- Federal Reserve aggressively raising interest rates by 75bps
- Federal Reserve indicating they will raise rates another 150bps over next 3 meetings
- Federal Reserve will begin QT
- Federal Reserve job of soft landing very difficult as only 3 have occurred (1965, 1984,1994)
- Market rapidly priced in multiple rate hikes in short period of time
- Global central banks, ex-China & Japan, following Fed
- Soaring consumer borrowing costs for mortgages & car loans
- Supply chain disruptions:
- Ukraine war: energy, fertilizer, grains, etc.
- Extraordinarily tight refining capabilities for diesel and gasoline
- China COVID shutdowns
- Lack of semiconductor chips
- Drop in auto production from 17m to 11m
- Severe weather
- ESG focused investors inhibiting fossil fuel production
- Drought conditions for grains in US and Brazil
- COVID bankrupted US oil companies
- Financial speculation unwinds:
- HY debt
- Fiscal tightening with US government outlays -20% in 2022 from 2021.
- Main drivers of CPI, energy, food, & transportation, not strongly impacted by rate hikes
- CRE office space high vacancy rates
- Summer demand for gasoline and jet fuel for vacations travel increasing demand for energy and maintaining high oil prices
The stock market bears have a strong case as Fed raising interest rates will impact fully with a lag, impact housing quickly and address supply chain issues unless they pulverize the economy to reduce demand.
Here’s how the bears get to 3000 on the S&P 500:
Let’s look at the ignored positives for the economy and stocks.
- Reopening of global economy from COVID
- Consumer balance sheets in excellent condition
- Corporate balance sheets in excellent condition
- No 2008 GFC as banks have large capital reserves
- Much of crazy speculation has already been crushed
- Fed can walk and chew monetary bubble gum on rates as financial conditions tighten
- US oil & natural gas production is ramping up quickly with 2022 rig counts +59% (total 733)
- Russia crude supply not falling dramatically
- US Treasury 2-year notes attractive to underinvested institutional buyers at 3.10%
- China stimulus and recovery from shutdowns
- Ukraine war likely settled in H2 2022.
- US consumers shifting from goods to services spending
- Eases supply chain pressure for goods (see Target and Walmart inventories)
- Eases price pressures on electronics, cars and furniture
- Eases wage pressure eventually on transportation, warehouses & manufacturing
- Eases port congestion and reduces tanker costs
- US state fiscal coffers are full and will be spending on infrastructure
- Growth vs. Value ratio nearing LT trend
- RTW will continue to as COVID reopening accelerates
Here’s how the bulls get to 4000 on the S&P 500:
On forward EPS, here’s some context according to FactSet:
5-year average 18.6
10-year average 16.9
15-year average 15.5
20-year average 15.5
25-year average 16.5
How an investor views today’s markets is a function of time frame.
ST, the bears are in control with a strong negative narrative driving down equity values. This narrative is likely to persist over summer as risks from an extended Ukraine war or a refinery explosion provide fuel for pessimism.
MT, the bulls will see their day as many of the negatives are ST. LT, equities remain a reflection of the ability of public companies to create profits for shareholders. This robust capability is why stocks remain attractive at these levels despite current strong negative market narrative.