Monthly Outlook: July 2022
Our iFolios growth portfolios beat their market benchmarks by 4% to 5% in June. We did that by not losing (much). Since January, when nearly every market turned from uptrend to downtrend, we’ve been selling and raising a lot of cash. We simply followed the trends and invested accordingly. We didn’t guess or predict, and we didn’t fight our signals. As we start the second half of 2022, the trends remain firmly downtrending and so we remain resolutely in protection mode.
Markets have been remarkably weak this year, so far. The S&P500 is down 19.9%, the NASDAQ is down 29.3%, and international stocks are down 18.8%. Even bonds have lost 10.3%, and that includes interest. Cash, paying next to nothing, is a far better temporary holding than nearly any other market. With markets down so much, many investors are tempted to believe that we’re somewhere near “the bottom.” With prices 20% to 30% off, they suspect that stocks must be a good value here for the long run. Our performance this year shows that we’ve been good at calling the trend of the markets. I’m telling you directly: this is not “the bottom,” and we do not recommend buying this dip. Rather, if we’re lucky enough to see a 5% to 10% bounce over the next month or two, we’d prefer to sell the rally and get protective. It’s not too late to sell, and we know that many investors (not ours) are stuck with losing positions and uncertainty. Sell the rallies or let us do it.
What Do Market Bottoms Look Like?
Although markets are down 20% to 30%, we do not see the conditions that almost always occur with final market bottoms. In fact, we’re not even close. It’s often said that at “the bottom,” most investors won’t ever want to buy stocks again. That’s not the prevailing emotion today. There’s still too much “fear of missing out” and too many pundits selling optimism and recommending investors buy, buy, buy!
To simplify, we can focus on three key indicators for identifying market bottoms: 1) valuations, 2) interest rates, and 3) unemployment rates. Valuations remain at near-peak levels, despite 20% to 30% price declines. Whether we use price-to-earnings, market cap-to-GDP, or others, valuations need to decline to at least their long-term mid-point to indicate a market bottom. Not only will market multiples (the numerator) decline, but earnings, GDP, etc. (the denominator) will surely decline, too. This is a double whammy and tells us that further stock price declines are likely. Interest rates have risen lately, and the Federal Reserve is playing catch up by raising their Fed Funds rate to slow inflation. Historically, markets don’t bottom until the Fed finishes their rate hikes and start lowering the Fed Funds rate. They’re still in the early stages and raising rates. Lastly, unemployment is at 40-year low levels of about 3.6%. Every market bottom has occurred only after the unemployment rate rises by at least 3%. While we’re starting to see rising initial unemployment claims and a few layoff announcements, the unemployment rate needs to rise a lot before the markets bottom. The takeaway is that markets look much more like the beginning of a bear market than the end.
Is There Any Optimism?
No one likes to hear bad news and I take no delight in delivering it. The economy and stock markets continue to decline, and we don’t see any imminent change to the downtrends. The good news is that we’ve already taken significant steps to protect our investors from loss. Sometimes, like right now, not losing is the best you can do. We’re also very optimistic that once this market downtrend is over, we’ll have good opportunities to use our sizeable cash hoard to buy quality investments at value prices. That’s the key to making real money over time. We do see the beginning of some strength in the bond market and have been adding some longer maturity bonds back to portfolios. This may seem contrary to some investors, but we see some indicators that interest rates in the 2-year to 30-year part of the yield curve may have already peaked. Lastly, we’re all aware of sky-high oil and gasoline prices. Here, too, we see some early indicators that these prices may have peaked. It may take some time, but we’re confident that inflation will be tamed, we’ll have good opportunities to buy stocks cheaper, and we’re protected from loss in the meantime.