2022 Mid-Year Investment Outlook: Embrace the Stock Market Sale
I begin this investment newsletter with the bottom line, stated plainly: long-term investors should be pleased to invest in the stock market when stocks go on sale.
From Warren Buffet’s 1997 annual letter:
If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? … But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.
… So smile when you read a headline that says “Investors lose as market falls.” Edit it in your mind to “Disinvestors lose as market falls — but investors gain.” Though writers often forget this truism, there is a buyer for every seller and what hurts one necessarily helps the other. (As they say in golf matches: “Every putt makes someone happy.”)
We gained enormously from the low prices placed on many equities and businesses in the 1970s and 1980s. Markets that then were hostile to investment transients were friendly to those taking up permanent residence.
The market is on sale now:
The easy questions:
- Is the market on sale? Yes
- Does market history provide strong evidence that buying 20%+ pullbacks is a winning strategy for long-term investors? Yes
On to harder questions:
- Does this current market sale offer good bargains?
This depends largely on what happens next in the global economy. Will inflation come under control, and can it be tamed without significant demand destruction (which would likely constitute a recession)?
If corporate earnings come in anywhere near consensus over the next 18 months, stocks now offer pretty good value. Consensus S&P500 earnings estimates for 2022 are 224.5 – 229.6, which places the price to earnings ratio at 16.5x. Consensus S&P500 earnings estimates for 2023 are 248.4 – 252, which gives you a forward p/e ratio of 15x. The five-year average for this figure is 18.6x and the 10-year average is 16.9x. This data point indicates enhanced value, but I for one lack confidence that we will realize the earnings growth baked into consensus estimates as the Federal Reserve tightens monetary conditions and extremely elevated corporate profit margins are tested.
The market is on sale now, but will there be a clearance price somewhere below this? Maybe … any call with great specificity I would liken to a “Red 7” call at the roulette table. Everyone would love to sell out and buy at the moment markets bottom but those attempting to do so are destined to fail. Consider when the market bottomed in late March, 2020 as a cautionary tale. In the span of four trading days, the S&P500 rocketed forward 20.31%, trough to peak.
- Will we have a near-term recession?
The Fed faces a historic task as money supply increased 40.1% in the two-year timeframe ending in February 2022. Broad inflation impacts fueled by a self-injurious energy policy, geopolitical risks including Russia/Ukraine, and a vanished labor force round out a solid list to worry over.
- If we experience a recession, what happens to the stock market?
I will attempt a prediction utilizing two methods:
Method 1: Based on Recessionary Earnings
In the average recession, corporate earnings drop 30%, which would take S&P500 annual earnings to $160. Applying a multiple of 20x earnings would take the S&P500 down to 3200, about 15% below current levels.
Method 2: Based on Stock Market History in Recessions
In the 13 recessionary corrections since 1950, the stock market has on average dropped 29.1%, peak to trough. The average timeframe for this peak-to-trough move is 339 days. Applied here, this calls for the S&P500 to bottom in November, 2022 right around 3400, about 9% below current levels. If history repeats, the forward-looking market would likely bottom well before the end of the proposed recession.
Inversely, if we skirt a recession, this market drawdown looks overdone. The 23 non-recessionary corrections since 1950 on average saw a 15.1% drop over 118 days, peak to trough. We are now 190-230 days into this pullback with recent bottoms representing maximum drawdowns of 24.5% and 34%. It should also be noted here that the current market drop exceeding 20% places us in a technical bear market and we’ve only seen two non-recessionary bear markets since 1950. Said another way, the market is pricing in a pretty good chance of a recession.
Prudent asset allocation calls for spreading bets but this hasn’t helped investors much in the current pullback. Over the 41 years preceding 2022, in only one year did we witness stocks and bonds, the twin opposing pillars of portfolio construction, fall in the same year. It was 1994 and stocks were down slightly while the US aggregate bond index dropped 2.9%. In 2022, we’ve experienced the almost-never-seen simultaneous drop in both stocks and bonds, with the S&P500 down 21.5% year-to-date, and the bond market down 11.6% year-to-date.
Everything is down. Everything is on sale. It may not be the bottom, but long-term investors should be pleased to buy this pullback and to plug their monthly 401(k) contributions in at more attractive levels.
 3/23-2020 – 3/26/2020; 2191.9 to 2637
 190 days and 21.5% for S&P500; 230 days and 29.1% for Nasdaq
 The S&P500 index level dropped 1.5%; investors actually registered small positive total returns when including dividends.
 Bloomberg Barclays US Aggregate Bond index
 Even worse, the largest long-term corporate and treasury bond indices are down roughly 23% YTD