Stocks fell 2% last week in volatile trading.
The market may squeeze higher into the year end because investors are currently extremely pessimistic.
However, fundamentally nothing has changed. Stocks remain overvalued in light of the massive increases in interest rates this year.
“Most traders today don’t have good perspective about how long can take to find an equity bottom in a downturn”, writes Bob Elliott on Twitter. Historically, it has taken 1.5-2 years for a bear market to end, which would put the bottom around mid-to-late 2023. “It feels each day that many are desperate to market the turning point. I feel its in large part from normalizing the idea that cycles bottom really quickly. And that’s just not the case,” continues Elliott.
Elliott notes that it may take larger than expected interest rate increases to slow down the US economy, and thus the US central bank still has work left to do.
The interest rate increases that are happening this year should, if the historical pattern holds, slow the economy down dramatically by late 2023.
But analyst earnings estimates are still elevated and inconsistent with a recession.
It also turns out that despite record pessimism, investors keep more of their assets in stocks than at previous market bottoms.
Thus, we judge that there are still investors in the market who hope that things will not get worse, or that they will quickly get better, leading to repeated bear market rallies.
These hopes may be dashed if we are undergoing a regime shift, as Jens Nordvig argues in his new piece “Asset Ownership vs Asset Management”.
The past few decades have been exceedingly easy for investors, writes Nordvig. During this period, mantras such as “always stay invested” and “cash is trash” became popular because they worked. But, contends Nordvig, “The investment lessons that may have been correct in a world of stimulative central bank policy (and ‘centra[l] bank puts’ protecting asset markets), are no longer valid.”
We tend to agree. We believe that in the coming decade, passive investing will produce mediocre results. “Just stay invested”, “stocks always come back”, “be patient”, etc., will turn out to be the wrong pieces of advice. Instead, active security selection, a tilt towards Value stocks, flexibly varying allocations between cash, commodities, and equities, and success at macro forecasting will be required. The winners of this decade will look very different from those of the past, in our view.
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A position was initiated in $D (Dominion Energy Inc), an oversold stock from the US Utilities ($XLU) sector. The stock has fallen 20% in the last month and a half and now trades at 5-year lows, while its valuation has fallen to a 10-year low. We hold the stock in the expectation that stocks may rally into the year end if interest rates stabilise.