The Death of a Bull
Global equity markets continued their sell off during the second quarter as economic conditions around the world deteriorated. An aggressive Federal Reserve raised the Fed Funds rate to pre pandemic levels, causing more drops in bond prices. With inflation continuing to rise, the Fed seems willing to risk a deep recession to get rising prices under control. Stocks entered bear market territory during the quarter, with a 20% pullback from their highs. The yield curve inverted during the quarter, signaling that a recession is likely. Most economists have stopped talking about whether a recession is likely and are now discussing how bad the recession will be. In fact, we could very well already be in a recession now, as GDP contracted in the first quarter. A repeat of this in the second quarter would meet the definition of a recession. While a recession is not a certainty, it is looking more likely than not that we will see one.
It is easy to look at the last six months and talk about what has happened. The more difficult thing is to predict what will happen the next six months. In the short term, we are probably over sold in the stock market, and a rally from these levels would not be a surprise. However, we feel we have probably not seen the low point for stocks. On the bond side, we feel most of the damage has already been done in the bond market, although persistent inflation could mean there is more selling to be done. Keep in mind the average drop in stocks during a bear market is 36% and right now we are down roughly 20%. The average bear market lasts close to one year, and we are six months in. When you consider the fact that earnings multiples were near all time highs in December, we likely have more room to fall.
Bear markets are scary. The longer they go on the more frustrating they become, and there is a tendency to want to do something to stop the pain. Making investment changes based on emotion almost always leads to bad outcomes. This market is more painful than most because bonds are dropping as well and there is no place to hide. The worst bear markets seem to last forever, and the losses seem irreversible. Fortunately, this is not true. Every bull market begins after a bear market ends. The largest market gains come after the biggest market drops. The best investment approach is to be a buyer as the market drops rather than being a seller. While we are not yet adding to our equity positions, there will be a time that stocks look attractive, and we will begin shifting more money into stocks.
In the meantime, history tells us that the best approach to markets like this is to hold the course and stay focused on the long term. As we have during the first half of the year, we will continue to make adjustments to our portfolios as conditions change. Markets typically hit bottom well before the economy does, so our focus is on equity valuation and economic performance.
Wabash Capital
