Ketu Desai
By Ketu Desai
Panic seems like the most appropriate word to describe June. Investors panicked. Bank of America Bull & Bear indicator hit zero. The percent of stocks trading above their 50D moving average moved below 2 percent, near levels seen at major market bottoms during COVID and 2008. We had a period during the month in which 5 of 7 days had more than 90 percent downside volume. This has never happened in data going back to 1928. Hedge fund selling hit 4.5 standard deviations for a period during the month. One in eight public companies trade below cash and cash equivalents. Systematic positioning sits in the 2nd percentile, and consolidated positioning in the 6th percentile.
Central banks panicked. The Swiss National Bank did a surprise 50 bps hike. It’s first hike in 15-years. The ECB just a few days after talking tough on tightening held an emergency meeting to discuss a way to control yields. The Fed panicked. After taking 75bps off the table in May, hiked 75bps in June. The good news is that when central banks are panicked about inflation the market doesn’t need to. We saw that in the aftermath of the mid-month panic.
With central banks panicked about inflation, investors shifted their attention to growth. As the Fed fights inflation, growth is slowing, and perhaps on its way to contracting. Yields backed off their mid-month peaks. Importantly, the 2YR, a proxy for monetary policy, is down nearly 50 bps from its peak. 5YR break-evens are near YTD lows. Commodities also made a meaningful move lower. Natural gas looked like it was headed well into the double digits, traded back down to $5.55. Copper, a global growth proxy, is now down YTD. Fed funds futures are looking for cuts in 2023. The economic data also shows growth weakening. Citigroup economic surprise index is well into negative territory. Retail sales have weakened, PMIs look to be heading closer to 50 and maybe below, initial jobless claims are moving up. The bigger picture in 2022 is that markets are correcting the excesses of the pandemic. The slowdown in growth is part of that process. It’s possible that we could have a contraction in real GDP and positive nominal GDP. The market will bottom well before GDP will. In each of the last six major post-war business cycle downturns, equity markets bottomed as the economy was getting worse.
For long-term equity investors, we are getting an opportunity to upgrade our portfolio to some of the highest quality companies trading at much more attractive valuations. The risk / reward favors buying profitable growth stocks and high-quality value stocks. Google (Alphabet) is an example of a high-quality growth stock. It trades at 16.3x forward earnings, or a 30 percent discount to its historical valuation. It trades around a market multiple while providing more than double the expected earnings growth. Google gives you exposure to some of the most exciting technology verticals such as digital advertising, search, cloud, autonomous driving, and artificial intelligence.
JP Morgan looks like a value stock that is attractive. During the month, it traded back down to levels last seen during the early months of the pandemic. It trades at just 8.8x forward earnings and 1.2x book value. JPM pays a 3.5 percent dividend, has a healthy buyback, is expected to have 13 percent earnings growth next year, and has guided to 17 percent return on equity for both this year and next. It benefits from rising rates, and if growth does slow meaningfully, it has a balance sheet to withstand it with 12 percent in tier 1 common equity. With all the damage, there is a long list of such companies that are attractive. Amidst the panic, long-term investors are getting an opportunity to buy some of the best businesses in the world. Companies that have been through far worse and thrived. They have the best balance sheets in the world, earnings power, most have high barriers to entry, most pay dividends and have a buyback, access to the best resources, the cheapest financing, and strong brands.
Looking forward, the market will focus on economic data, geopolitics, and second quarter earnings.
Ketu Desai is the Principal of i-squared Wealth Management Inc. (www.isquaredwealth.com), an investment management firm based in New Jersey. ketu@isquaredwealth.com
