Stock Market Drop Accelerated as Recession Seemed More Likely

Investors had a terrible start this year as stocks entered the bear market territory twice and fell by more than 20%. Stocks didn’t stay there for long at first, but the second decline as Wall Street began to accept that inflation was more sustainable and the Federal Reserve had to be more aggressive to fight it. Proved to be more durable.

The S & P 500 fell 16.4% in the second quarter, 20.6% below the level at the end of 2021.

Where are you going from now on? Sure, stock rebounds seem natural, but investment advisers have said that a sustained recovery is unlikely so far. They warn that if the recession isn’t here yet, it’s probably underway and remains highly rated after a significant fall.

Meb Faber, Chief Investment Officer of Cambria Investment Management, said: “You can easily lower one-third from here to go back to past ratings.”

Ella Hoxha, manager of Pictet Asset Management’s global fixed income portfolio, said expectations have not yet been adjusted to incorporate the potential risks of a recession. It may seem surprising that a recession can surprise Wall Street when there are few other conversations out there. But until recently, Wall Street has downplayed that opportunity and talked about the prospects for a soft landing that will slow growth but avoid large-scale, long-term turmoil in the economy.

“The possibility of a recession has risen, but in the event of a recession, the market has not yet fully priced,” Hoxha said. “Last year, the Fed must not only correct its dovishness, but also break its balance sheet by selling bonds and other securities it buys to support its economy and markets.”

Market forecasts are increasingly guided by assessing how serious the recession will be, not whether it will occur. However, the deterioration of the economic outlook may still be ahead.

Ron Temple, Managing Director of Lazard Asset Management, said: According to him, most people still expect a “short and shallow recession.”

The recession hits stock prices primarily due to lower corporate profits. Just as investors aren’t fully considering the recession, Temple said it may need to lower earnings expectations further before stocks bottom out.

“One of the missing parts of this story is that earnings expectations are probably not in the right place,” he said. “Probably more downgrades will be seen.”

In his view, the most likely result is a further 10% decline in stocks, and his “bare case”, which could be related to another bad inflation report, is that stocks yield as much as 25%. Is to fall. The 10-year Treasury will rise from just under 3% on June 30 to 4%.

Owners of domestic equity funds know everything about the bear case. According to Morningstar, the average portfolio in the second quarter fell by 15.3%, with funds focused on technology and consumer circulation companies losing more than 20% each. Still, funds that own utility and healthcare stocks were able to keep losses in the single digits.

Inflation and economic stagnation are not the only phenomena in the United States. Europe has the same problem, and there are some specific problems that make dealing with them a problem.

Average international equity funds fell 13.3% in the quarter, and European and Latin American portfolios were slightly worse than average. The Chinese fund managed to make a profit of 3.7%.

The nearly unavoidable loss of equities is usually mitigated by rising long-term government bonds, as yields fall due to the economic downturn as the recession approaches. An average 20% decline in stocks is consistent with a 12% rise in Treasury prices over a 10-year period, according to a Citi Research report.

Not this time. Bonds also fell when stocks began to fall this year, perhaps because the Fed artificially lowered interest rates and quantitative easing to distort the bond market. In the first half of the year, government bond iShares exchange-traded funds for more than 20 years fell by 22.5%. The S & P 500 SPDR, an ETF that tracks its stock index, fell 20.6%.

According to Morningstar, the average bond fund in the second quarter fell 5.7% as the long-term government bond portfolio fell 13.1%. High yield and emerging market bonds also suffered higher than average losses.

Under the best conditions, deciding where to put money is not easy and the current situation is far from that. Beyond inflationary backgrounds and concerns about recession, until the effects of federal tightening become apparent as the pandemic era measures are lifted and the trade turmoil caused by the war in Ukraine passes through the economy. It is certain that the certainty will last for several months. ..

Hoxha recommends long-term government bonds after the blow they suffer, but her call is less of a support for them than a contempt for everything else. She will avoid short maturities of up to two years and corporate and European debt.

“When you can get a yield of 3.5 and the outlook for stocks is unclear, you will start paying a premium to your Treasury and will probably be better than getting it in cash,” she said. “But don’t put everything in. Some cash with some Treasury may be a good combination.”

Mr. Farber feels that American stocks are expensive, but “the valuation of foreign developed markets is perfectly reasonable, emerging markets are really cheap, and both value cohorts are cheaper than the broader markets. “

He likes high quality value stocks. This means a company that produces enough cash to return money to shareholders on a regular basis through dividends and repurchases, but with a low multiple of earnings.

Farber believes that investors can double their profits when they buy value stocks.

“It’s good because it’s cheap, and because you’re avoiding stupid and expensive things,” he said. “Last year, by avoiding really expensive things, we really saved everyone’s bacon.”

Saira Malik, Chief Investment Officer of fund manager Nuveen, prefers American equities. In her investment outlook presentation, she emphasized quality, as Mr. Farber did, and emphasized features such as a resilient balance sheet and the ability to increase dividends. But she prefers growth stocks, that is, stocks of companies that are less sensitive to economic ups and downs.

Among bonds, she and her colleagues will support municipal and high-yield bonds and limit their exposure to long-term government bonds.

Temple said he thinks trying to choose between value and growth stocks is counterproductive. His advice is to adopt either as long as you stick to quality. This is what he defines as a “sustainable company with a high rate of return on capital.” When investors seek security and the economy weakens, the stocks of these companies usually get better. But this year the quality has underperformed.

Companies he likes and is marked down include Microsoft, Amazon, and Google’s parent company Alphabet. All three are in a position to benefit from the ongoing migration of business computing to the cloud. Temple also recommends the payment card networks Visa and American Express.

He acknowledged that the stocks of these companies may need to fall further, as well as the market widely. But he said he expects them to be a solid purchase over the long term, even if holding them for the next few months may be uncomfortable.

“I’m not smart enough to choose an absolute low,” Temple said. “There are very good quality companies on the market that we want to own for the next 3-5 years. As this sale continues, we will see more opportunities.”