I’m starting out with my customary warning that my temperament is such that I’ve gotten more than all my outperformance as an investor in up-trending and flattish markets. My idea of success in a down market is not entirely losing my shirt. The main issue is that in sizing up the market in general I look much harder for what can go right than for what can go wrong. I do more or less the right things in a bad market–rotate into larger-cap stocks vs. smaller, low-PE vs. high, stable vs. cyclical, less concentration in a few names–just not enough of each to keep up with the market.

This is presumably not news to regular readers, so this “disclaimer” is as much to remind myself as you that most of what I think is tinged with optimism. While on average this may be the most useful frame of mind to be in, it’s not the way to go in a market downturn.

Yesterday, I wrote that the typical cyclical bear market lasts anywhere from 8-12 months. By that yardstick, and assuming the down market began last November, we shouldn’t expect a market pickup until the fall. The big issue with this train of thought is that the overriding economic factor isn’t the business cycle but the multi-year bolt from the blue of the pandemic, together with the much lesser negative of the invasion of Ukraine, which shows up in the stock market mostly through rising commodities prices.

Another complication, with another disclaimer: at one time I had a seat for the stock market game at field level, right behind the catcher; I’m now high in the bleachers. From where I now sit, however, a lot of current trading seems to be handled by AI that react to news stories, corporate announcements and recent stock price action. Are these trained on data from periods of external shock, like the runaway inflation of the late 1970s-early 1980s? …or are they trained on 2007-09, when world trade ground to a halt on worries about the solvency of the global banking system? …or do they mostly respond to the financial media, which I see (the Economist, Nikkei News and the FT excepted) as an echo chamber of cluelessness.

My point is: to what degree can we depend on reading stock prices as an indicator of market sentiment? I’m not sure. On the other hand, it may be all we’ve got.

AAPL, for example, reported after yesterday’s close. The results were fine. The company warned, however, that revenues (i.e., not profits) for the coming quarter would be lower by maybe 5% than they would have been had China not been having covid-induced factory lockdowns. The immediate press reaction was negative. As I’m writing this about an hour before the open, AAPL shares are down by less than a percent, with NASDAQ futures off by more than a percent.

I read this as a bullish-ish sign. An important step in the market recovering its equilibrium after a decline has always been that it stops discounting bad news over and over. Although I’m not an AAPL fan and I don’t know much about the stock, it seems to me that the Chinese factory shutdowns should have already been well-known (and already factored into the AAPL stock price) before last night’s earnings call. The “news,” if there was any, is that production is already up and running in non-covid areas. Two more nuanced takes: revenues will be down by mid-single digits, but this doesn’t imply that profits will fall this much; and revenues will be down from what they would have been otherwise, not down in the absolute–maybe they will be up by 30% vs. AAPL’s former internal forecast of +35%.

In any event, AAPL gave the overnight market an excuse (not a reason) to sell off it wanted. So far at least, that hasn’t happened. Like the reaction to recent MSFT and FB reports, this is an encouraging sign.

Recently, two thoughts about the overall US stock market have been rattling through my brain pretty consistently:

–at one point back in the dim past of the last century (I think), the market strategist for Goldman, Abby Joseph Cohen, opined that we were in a bear market in time, not in value.

(An aside: the problem I always had with Goldman equity research when I was working is that the macro- or microeconomic analysis was always at least as good as anyone else’s, but that the analysts always struggled to connect their elegant theoretical construct to what was happening then, or what was likely to play out later, in the real world of Wall Street. Sort of like offering great stratomatic baseball tactics as complete solutions for running a professional team.)

It almost never happens in the real world that markets go sideways. Usually they either go up or down. But that time Ms. Cohen’s unusual conclusion was exactly on the mark.

–I read a comment from an online source I can’t recall (skimming is an incredibly useful skill for investors, I think) that made the same kind of comment, adding that day-to-day volatility would likely remain high. “Violently sideways” is how I filed it away.

Put another way, this claim is that all the bad stuff is out in the open and has been mostly discounted and good things could actually happen–during a period when the prevailing market sentiment is gloom and doom.

Real world support for the latter idea comes in the good earnings, and post-report performance, from MSFT and FB.

Looking at this neon light from the unconscious mind from another perspective, the overall US stock market has been in decline for about half a year. During this period, the S&P is down by 10%, NASDAQ by 20% and ARKK by 60%. One could argue that this is enough stock market damage for a world economy–and a US, in particular–that is arguably in recovery. Interestingly, since the invasion of Ukraine, the S&P is off by less than -0.6%, NASDAQ by -3.5%. ARKK has lost about a quarter of its value (that’s a story for another time).

On the other hand, a typical bear market lasts for at least 8-12 months. This would imply a potential upturn during the summer at the earliest. Given that June-August are usually pretty dead times for Wall Street trading–as most major decision makers go on vacation–September might be a better guess.

more tomorrow

The 10-year Treasury note started out 2022 with a 1.63% yield. Two days ago, the yield reached 2.97%, before retreating a bit to 2.89% as I’m writing this on Friday morning. This compares with a rise of the Fed Funds rate for overnight bank borrowing of basically zero as the year opened to something slightly south of 50bp today. So, say +50bp vs. +134bp, showing what typically happens in the interaction between the Fed and the bond market–the Fed indicates, the market reacts, and the Fed follows up with moves that validate the bond market response.

My position has been that, after post-pandemic ructions subside and assuming Ukraine won’t get much uglier than it is now, we end up with inflation of 3% and a 10-year Treasury note that yields 3.5% – 4.0%. The most salient point is that rates are going up, so I don’t see any need to fine tune my guess until we get into this range.

I suspect that most professional equity investor hold similar beliefs, and have held them for months. If so, however, why does Wall Street continue to react negatively with each nudge upward in the 10-year, rather than discount the move–to 3.5% at least–all at once.

I have no idea, but in the 40+ years I’ve been involved with stocks, this is what has always occurred. So it’s no surprise that choppy waters is what we’re dealing with now. My guess is that this will be the order of the day for equities at least until we get to 3.5%.

I’m looking at three stocks as bellwethers:

HOOD, which I started buying about a month ago, and which I think is trading at very close to its net asset value–meaning there’s very little, in my view, in the price for its being a going concern. It bottomed with the rest of the market on March 14th, returned to fall slightly below that intraday yesterday, and is trading around the same value as I’m writing. I think that stability in stocks like this will be an early sign that the market is shifting to other ideas than simply rising rates.

ZM, which I don’t own, and which I regard as a stay-at-home stock, will likely struggle in a post-pandemic world. It also bottomed on March 14th but is trading about 6% above that now. Although I’m less optimistic about ZM, I still think that we may again be establishing a price here where the market is already discounting all the bad things that higher rates and a more normal economy may well bring.

W, which I don’t own, has two strikes against it. It’s a stay-at-home stock which is also tied to the housing market–which is likely to be the primary economic casualty of rising interest rates. It bottomed on March 14th, but has resumed its decline over the past week or so. It now trades at almost 20% below its 3/14 close.

What ties all three together is that all are non-tech and each has lost about 3/4 of its peak value. An important early sign of market healing, I think, will be when investors begin to root through rubble like this for stocks that have been sold off too much. It’s still very early, but that may be happening now. I think the most likely direction for the market is still sideways until we get to 3.5% or so, but this kind of bargain hunting would be an encouraging sign.

…continuing from yesterday:

–factor investing has been around for at least thirty years, maybe more than that, but I only became aware of it as a thing in the pension market in the 1990s. A broker or pension advisory firm creates a group of stocks that embody a concept that an investor might be willing to either bet for or against. Concepts or factors might be: large companies, small companies, most sensitive to oil price changes, most sensitive to interest rate changes… Ones like “oil” are created by regression analysis. Others can be made from computer screens. A recently popular one is, I think, “yuc,” young unprofitable companies, which already contains a sign of the way the creator wants the user to go.

Their appeal is simplicity, Their drawback is that, in the past at least, they’ve tended not to work particularly well. My sense is that this is because, although a given factor may be a reason for profits to vary, it’s often not the most important–or even if it is, there are half a dozen offsets.

I’m interested in picking through the wreckage of the yucs. Many are indeed yucky, but some have tangible and intangible assets that earnings screens ignore completely.

–“discounting” is stock market jargon for the process by which investors factor future prospects into today’s prices. Typically, investors have tended to factor into today’s quote their expectations for company developments over the coming year. In a very frothy market, one year may become three. In a bear market, investors tend not to pay anything for future events, not matter how near or haw much conviction they have.

In today’s world, though, a significant amount of price determination comes from machines reacting with lightning speed to just-released news. One of my early work friends had a boss who got ideas from reading the Wall Street Journal from back to front, with emphasis on small-print compilations of the earnings of obscure companies. That doesn’t work any more. It seems to me our best course of action is to take a longer investment horizon that these rapid traders do.

–during my working career I found two sure signs that I was dealing with a know-nothing: talking about the Dow and talking about the effect of politics on the market.

The Dow is, if anything, a more solid indicator than it used to be.

Politics is another issue, I think. While the Reagan Revolution did achieve the modernization of antiquated American plant and equipment, it also ushered in a long period of neglect of infrastructure, education and a lack of retraining, unique in the G-7, for workers displaced by globalization and technological change. If the US is in a race for world economic leadership with China, a country with over 4x our population, then the anti-growth, anti-science, anti-progress agenda of the Trump wing of the Republican party is a very bad place to be. Then there’s the coup attempt and his support for Russia in Ukraine …and the Democrats’ inability/disinterest in offering any credible alternative. During Trump’s term, the clear winning stock market strategy was to focus on publicly listed multinational businesses with limited plant and equipment in the US. It’s not clear to me that this won’t happen again.

I’ve spent the past few days tying myself into knots in an unsuccessful attempt to articulate a coherent overall portfolio strategy.

The main near-term issues I think the stock market is facing are:

–recovery from the pandemic

–raising interest rates back to normal from their emergency lows of the past couple of years

–how persistent inflation will be

–the extent of reshoring industries outsourced to the developing world

–the war in Ukraine

–changes in the market’s discounting mechanism

–factor investing

–relevance of toxic politics.

Taking these in order:

–it seems to me that when the new administration shifted from pandemic denial to pandemic cure, the US has moved into the forefront of the back-to-normal movement. The past year has been all about separating purely stay-at-home beneficiaries (bad) from winners from pandemic-induced lifestyle changes (good). I expect this will continue, with new questions, like the value of midtown office space, coming to the fore

–I’m thinking the 10-year Treasury will end up somewhere around 4.0%, with the Fed Funds rate at 3.0%. This implies that inflation will settle in around 3%.

The 10-year is now yielding about 2.7%, up from 1.5% last December. So we’re basically halfway there. A consensus seems to be building that the US stock market made an important low about a month ago. But because the stock market continues to react negatively to any move higher in Treasury yields (despite the overall plan being pretty well known), it seems unlikely to me that stocks will run away to the upside

–I think the important inflation question is not about the current yoy price rise numbers but what the yoy figures will look like this time in 2023. My guess is that most supply chain issues will have disappeared by then. Two possible exceptions: semiconductors and, depending on how the war in Ukraine goes, oil. If this is correct, worries about a 1970s-style inflationary spiral as misplaced

–I think the biggest reshoring industry will be semiconductors, whose repositioning and capacity enlargement will go on for years. I think the largest response to higher oil prices will be intensification of the move to renewables

–the war in Ukraine. This is a major wild card. It seems to me that other than Russian oil, the world will find substitutes for the region’s exports relatively quickly. To me, the imponderables are whether Russian will escalate a conflict it appears to be losing and what their support of Putin will mean for the anti-growth political agenda of MAGA Republicans in the US.

more tomorrow, I hope