Navigating the 2022 Bear Market
High-level look at the bear market, changes over the year and last few months, and suggestions on how to proceed
Volatility can be unpleasant for many investors. It is not fun seeing cumulative gains wiped out in a matter of months, with no visibility as to when, or perhaps if, it will ever come back.
The compounding effects of the market only add to this. Consider the following.
An investment of $100,000 compounding at 10% for 10 years would yield a portfolio value of $259,374.
A 30% drop in the last few months would send the portfolio back to $181,562, effectively bringing down the 10% annualized returns to roughly 6%.
The last few months of an investment period can have a profound impact on the portfolio’s entire compound annualized growth rate!
Volatility is the price of admission in the market. It is the basis behind the correlation of risk & reward, more specifically the capital asset pricing model.
While investing in equities over the long term has historically yielded strong results, long term investors should accept the fact that the market will experience ups and downs.
Rather than worrying about downturns, investors should seek to understand, perhaps welcome, and possibly benefit from the opportunities.
Anatomy of the bear market
The stock market tends to rise slowly and drop quickly. In bear markets, the drops happen in stages.
Eddy Elfenbein’s analyzed and decomposed the Great Financial Crisis bear market.
“I think it’s better to see the market blowup of 2008-2009 in three segments. There was the “initial selloff” from October 9, 2007 to August 28, 2008. Then came the “panic phase” from August 29, 2008 to November 20, 2008. Finally, there was the “retest phase” from November 20, 2008 until March 9, 2009.
The initial selloff lasted 224 days and the S&P 500 lost 16.90% (blue line). The panic phase lasted 59 days and the market lost 42.15% (red line). Ouch! The retest phase was 72 days and the market lost 10.09% (green line).
My point is that the panic phase was by far the worst of the worst. By no means do I want to ignore the other two periods, but those were fairly standard lousy markets.”
Looking at the 2022 bear market, we see similar drops also with increasing intensity.
From January 3rd to March 14th (70 days), the market dropped 12.8%
From March 29th to May 20th (52 days), the market dropped 15.7%
From June 2nd to June 17th (just 15 days!), the market dropped 12.4%
Looking at it from another perspective, it took the market 150 days to decline 12.6%, from Jan 3rd to June 2nd.
In what may have been the panic phase, the market dropped another 12.4% in just 15 days.
While it seems we may have passed the panic phase of the 2022 bear market, only time will tell. There certainly is no guarantee as to the number of downdrafts in a bear market.
Is the tide turning?
Inflation, interest rates
The June CPI report came out July 13th. Inflation continues to climb, surpassing expectations and accelerating vs prior month readings.
“The all items index increased 9.1 percent for the 12 months ending June, the largest 12-month increase since the period ending November 1981.”
-Consumer Price Index Summary - 2022 M06 Results
The Fed, inline with their dual-mandate, is likely to continue hiking rates to combat inflation.
The market immediately began to price in a full 100 basis points increase for the July FOMC meeting.
Countdown to FOMC: CME FedWatch Tool, July 13, 2022
On Thursday, July 14th, the WSJ published an article paving the way for a 75 basis point hike. Expectations have adjusted since then.
Countdown to FOMC: CME FedWatch Tool, July 15, 2022
Bond market
Inflation is a lagging indicator. The market is forward looking. Although the CPI numbers came in higher than expected, the market took it in stride.
The bond market reaction is particularly telling. While short term yields continue to climb in response to rate hikes, the long term yields have been retreating. A yield inversion such as this is often interpreted as foreshadowing a recession.
The bond market is focused on what is going to happen later.
Macro Alf reported that the market is pricing in rate cuts of 100+ basis points between December 2022 and June 2024. This would be the fastest hikes-to-cuts cycle, ever.
As bond investors become more and more certain that the Fed will induce a recession and be forced to cut rates, they are looking to lock in what they perceive as high rates today. A safe yield of 3% looks good in a low interest rate environment such as the last few years.
Rotation under way
Commodities appear to have given up the majority of their gains this year.
The last month in particular has seen a drastic change.
Looking across sectors this year, energy has been the clear winner.
Since June, it looks like money started flowing out of energy and materials and into other areas of the market.
High beta stocks, after significantly underperforming the market year-to-date, are beginning to show signs of relative strength over the last month.
Uncertainty remains
There are many factors that play into the future of the economy and market. The drastic changes these last few years, and months, create an uncertain outlook.
Consumer confidence is down significantly. The University of Michigan’s index of consumer sentiment hit its lowest level on record in June.
The US treasury yield curve is the most inverted since 2000.
Mortgage rates are up significantly this year.. Housing prices, and relatedly rent, are usually laggards. The impact is yet to be seen.
Jobs are still plentiful. Job openings continue to exceed the number of employable persons.
There are some experts that believe forward earnings guidance expectation is too optimistic, and this might be the next shoe to drop. We’ll find out more in the coming weeks, as the earning season kicked off this last week.
While the market seems to have hit a local bottom on June 13th, it seems too early to say conclusively. The coming weeks will be particularly instructive.
How to proceed
Investors should listen to the market. The price movement can be revealing. This past week the market was resilient to some “bad” news, namely accelerating inflation.
As time progresses, investors should look for higher highs and higher lows to build on the constructive progress. The contrary – lower highs and lower lows - would indicate there may be more for the market to work out.
Taking lessons from history, one of the best ways to play through volatility is through dollar cost averaging. By investing a fixed amount every month, investors can take advantage of the volatility and minimize any possible regret.
In challenging times, it becomes increasingly important for investors to understand what they are invested in. Ultimately, it is the fundamentals that drive value. From the most basic principles, investors are after free cash flow – owning a business that generates cash that the owners can use.
On top of that, it is important to stay disciplined. Investors are best served reinforcing their rational thoughts and plans as opposed to yielding to their more spontaneous emotional reactions. There are many ways an investor can do this, such as through a clear investment agreement signed in advance (even if with themselves) or defining and sticking to a disciplined portfolio allocation strategy.
Know that, ultimately, this too shall pass. As mentioned in the opening, investing in equities over the long term has historically yielded strong results. Bear markets, in particular, tend to present attractive returns.
How the S&P 500 Performs After Closing in a Bear Market
Below are other articles I found particularly helpful:
Closing
Because markets are forward looking, they often bottom on increasingly bad news.
Investing isn’t easy. It takes a hard psychological toll on investors, more often emotionally. Many investors find the following graphic really hits home.
While investors should certainly observe and monitor the data, they are best served by sticking to their own plan and reinforcing their own convictions, as opposed to being swayed by the crowd.
Earnings season kicked off this week. In the coming weeks we’ll be hearing from some of our portfolio companies. Stay tuned.
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Torre Financial is an independent investment advisory firm focused on emerging and established compounders.
Federico Torre
Torre Financial
federico@torrefinancial.com
https://torrefinancial.com
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