The Dog Days of Summer Are Upon Us

The Dog Days of Summer Are Upon Us

August 03, 2022
Share |

Print / Read as PDF

The markets and the economy are based on simple principles of economics and forward progression of earnings to create proper (perceived) valuations for companies today and into the future. The massive amount of money that was thrown at the US economy in 2020 & 2021 fueled the expansion of markets in virtually all asset classes. Crypto continued its ascent, real estate continued rising to new levels (never before seen might I add), and the equity markets doubled from March 2020 to the November 2021 highs, a doubling that was the fastest ever experienced in market history. After this, Fed Chief Powell said that he was going to not only combat inflation that would surely occur but also cut off the excess money that was being pumped into the system.

It should not come as a shock that the markets could adjust. The answer that few have or could have had is to what extent should this pullback be. Again, on a topical basis, the US Economy is in fine condition. We have virtually full employment. We have rising wages. And even in the face of the market pullback, supply chain issues, China shutdowns, and spiking interest rates, we still have second-quarter earnings coming out above expectations and projections that are clearly not reflective of an economy in the throes of a slowdown/recession. I say slowdown/recession because there are some that feel that we will experience a soft landing rather than a reversal of growth to a negative measurement. The consumer representing the largest part of the economy, and flushed with cash, could we experience a totally different kind of recession that affects certain industries but not all?

According to Bob Brinker in his August commentary, "The economy is currently leaning toward a shallow, brief recession unless the Fed can somehow achieve a soft-landing. Consumer spending continues to benefit from the historic multi-trillion-dollar government money drop which occurred during the peak pandemic years of 2020 & 2021. Consumers also benefit from a strong labor market, accumulated savings, and the shift in spending toward services as the post-pandemic period gradually evolves. In the event the economy can traverse the current period of uncertainty, these will be the key factors responsible for the development of an economic soft-landing." Retail spending continues to be robust, but many are being scared by the excess inventories in retailers. It must be remembered that the consumer stockpiled everything non-perishable and due to their double or triple buying, the retailers hammered the distributors and manufacturers to hurry up and replenish their supplies only to find that since the COVID fear had abated, consumers used what they stockpiled rather than going out and buying more. Hence what I explained a couple of weeks ago in what is termed the "Bullwhip Effect." 

Now we are faced with the next dilemma. To what extent will the consumer be affected by the spike in interest rates? The Fed hit the rates with two massive increases within a period of 30 days--this window is not long enough to measure the effect on the consumer or on businesses. Following this, Chairman Powell expressed that the Fed would take a break in August and come back to revisit the rates versus the inflation and the economy in September. This more dovish commentary leaves the door open to waiting to see how these rate increases take effect on inflation and now having media heads grumble that maybe the Fed could be done raising rates for a while and maybe is getting ready to lower them to protect against any more of a decline that the aforementioned soft-landing.

Based on our expectation of 18-20 P/E ratios for the market in 2023 based on forward earnings, we expect the S&P 500 to reach new highs in 2023 and possibly challenge the 5,000 level on the S&P 500. Should this prove to be the case, the current situation could rhyme with the 1982 market as seen below:

The real question becomes one of valuation of companies and markets. Just as the markets have contracted based on fear of deceleration of growth rates, could it be that if we don't go into a prolonged recession quite possibly the pullback could be seen as an overshoot to the downside, and therefore all the cash that is sitting on the sidelines is forced to rush in due to FOMO (fear of missing out) by individuals and institutions.

Given the fact that 2022 is an election year, investors will be tuned in to the prospects for political change in 2023. Based on mid-term election history, we rate the probability of the House changing to GOP control in January at 90%. The battle for the Senate is too close to call. While the 2022 market weakness has exceeded our expectations, we are now well into the mid-term off-presidential election year period which historically produces an excellent buying opportunity. The most likely time frame for a market turning point to develop is from August to October, according to history. In looking at what is happening right now, the S&P 500 has begun to develop a head of steam and seems to be telegraphing some pretty nice recovery moves:

One other issue that I want to discuss is the bond market.  The rise in interest rates has devastated many investors in the action of the bond market. There has never been a period in time where the bond market got hit at the same time the stock market went through a major correction. Looking at the first six months of this year, compared with many past years, this year has been a devastating outlier in an asset class that has ALWAYS been a safe haven during stock market turmoil.

Imagine waking up at the end of June and seeing that your non-stock market portfolio of long-term bonds got hit almost as hard as the S&P 500!!! This has been sobering, to say the least. What has been good since the June 14th stock market low is that interest rates from the 5-year to the 30-year have been dropping. On the one hand, this is good as it is telegraphing to the markets that the interest rates by the Fed are taking hold and achieving their desired result, but on the other hand, if the rates are declining at too quick a rate, coupled with gasoline price declines and food price declines, could it be telegraphing that a recession is in the offing?

In the event, the market turns down in the weeks ahead, a successful test of the area of the mid-June S&P 500 Index lows could occur. I am not saying this to infer that this is what is expected, but that we must prepare for this possibility. This could set the stage for a pretty terrific potential to trigger a midterm election year buying opportunity if internal technical conditions become highly favorable. 

In the end, investors of all ilk are faced with a treacherous question of whether this recent recovery is nothing more than a typical bear market rally (which would precede another decline) or are we in the beginnings of a new bull market? When the 20-day High-Low for the S&P crossed above 50% and stayed there for at least two days, nine occurrences since November 1985 have proven to be a highly probable beginning of something much greater. Since there are so many issues that are so different about this current market, we can't bank on anything with 100% certainty, but what I do feel comfortable with is the way the big-cap tech companies have been acting after not-so-spectacular earnings seems to be saying that for many, the worst has been seen and reported and that it could be time to prepare for the next upswing. 

.

.

.

Get Ken South's Weekly Market Commentary Delivered In Your Inbox!

Click Here to Subscribe

-

-

-

-

Important Disclosures: 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy. 

Investing involves risks including possible loss of principal.

The Standard & Poor's 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.

The Nasdaq-100 is a large-cap growth index. It includes 100 of the largest domestic and international non-financial companies listed on the Nasdaq Stock Market based on market capitalization.

The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.