From an investment perspective, we at Integras Partners are glad to see 2022 in the rearview mirror. With multiple crosscurrents impacting investors’ ability to discern earnings and growth prospects, markets suffered a meaningful decline without settling on whether the worst is behind us. We expect uncertainty to stay with us for several months as future economic data comes in.
We continue to see two phases of this market decline, each phase driven by a component of stock pricing. First is the earning (or profit) potential of a company and second, how much investors are willing to pay for those unknown earnings. This concept also applies to other asset classes such as bonds and real estate. The first phase of decline happened in 2022 from the latter component, valuations coming down, which was fueled by higher interest rates. The second phase, which has yet to materialize, corresponds with decreasing earnings potential due to slower economic growth. This is what the market is currently struggling with – the uncertainty of how economic conditions will affect earnings and growth potential – the uncertainty of recession.
Whether the second phase occurs is unknown, but the damage done in the first was significant. High growth stocks were down 30%-60%, 20-year US treasuries fell 31%, growth underperformed value by an amazing 25%, and the list goes on. For the major averages, the S&P 500 ended down 18.1%, the small cap Russell 2000 down 20.4%, and the international EAFE index down almost 14.5%. Even the investment grade bond index was down 13%. The only places to hide were energy, utilities, consumer staples and cash. Virtually everything else ended in negative territory.
The list of conflicting indicators as to how the market may perform over the next 12 months is too extensive to complete the picture here, but we offer a few.
In the optimist’s corner…
Investor sentiment is terrible and positioning is quite defensive – indicating the environment is ripe for positive surprises. Earnings have held up well, economic growth is still positive, and employment is strong. Inflation has peaked, gas prices are down, Dollar strength has peaked, high-yield bond spreads are stable, and we are nearing the end of the Fed tightening cycle.
In the pessimist’s corner…
We are still in a bear market, technical patterns remain negative, and valuations are still too high. Leading economic indicators are the weakest since 2009, the bond market is priced for recession (since the 1960’s we’ve never avoided recession with the yield curve this inverted), the Fed is still raising interest rates, and the stock market has never bottomed before the Fed stops raising interest rates.
Until the recession question is answered, volatility will remain elevated, and no clear market direction will be established.
We believe recession depends on two key components – inflation and employment, and Timing is Everything.
Enjoy today and tomorrow, and let us do the worrying!
Contact us to discuss your situation if you’re interested in our time-horizon strategies.
