2022 May Market Notes
Continued bad news on the financial front this month as macro-environment threats continue to dominate headlines. There is no shortage of explanations as to why markets are in bear territory.
Last week we heard UK inflation hit a 40-year high of 9%. When the Governor of the Bank of England – not a man renowned for hyperbole - uses the word 'apocalyptic', you know it wasn't your average week.
Putin's war-of-choice rages on. According to NATO Secretary-General Jens Stoltenberg, "Putin wanted less NATO on his borders, now he’s getting more", following Finland and Sweden announcing bids to join, which could induce even more NATO provocations from Russia going forward.
Lockdowns in China continue to threaten global growth and supply chains. Shanghai seems to be on track for a slow reopening but Beijing is looking like a much harsher lockdown is increasingly possible.
Wall Street had its worst sell-off in two years last Thursday. The S&P 500 is down around 17% year-to-date. Inflation is rampant. The chance of the US entering a recession has risen.
Investors have been selling just about every sector and segment of the financial markets associated with risk and there has been no place to hide, but that is exactly what has to happen to complete the process of forming a bottom.
Where will it go from here? Well, my forecast will be as useless as yours.
But at a time when any cash savings are being plundered and eroded, we have to find ways to make our long-term savings work harder.
It's not easy to find things to be excited about and the good old days of being able to largely rely on the S&P 500 and a handful of tech stocks for growth are, for now at least, over.
Yet cash is not a viable long-term option, and there is still a tremendous amount of liquidity sloshing around in financial markets that needs a home.
Interestingly, S&P 500 earnings were up 20% in the first quarter when excluding the banks, which means that profit margins were still increasing. On that same basis, revenues rose 15%. The fundamentals have not deteriorated in the same way or by the magnitude that share prices have this year.
This is why valuations have declined so quickly, resulting in a price-to-earnings ratio for the S&P 500 that has fallen below its 10-year average. This does not mean that it wont't fall more, especially if investors panic and assume that a recession later this year is an inevitability.
The financial market is not the economy, but its losses will slow growth through a reversal of the wealth effect, which is why the Fed is not running to the aid of the markets as it has in the past. The market losses are another form of tightening financial conditions through which the Fed executed monetary policy.
It is clear that the S&P 500 is a lot less expensive than its current ratio when we exclude the top five technology-related market caps that account for around 20% of the index. The P/E multiples for Apple, Microsoft, Amazon, Tesla, and Google are well above the approximate 16.5x for the overall index. Excluding those names would bring the multiple for the S&P 500 well below its 10-year average.
In terms of riding out the current storm, we can do it in one of two ways. The first is to stay sensibly diversified with a good mix of things and then to do nothing. This is particularly the case for people with horizons of 5 years+. The hardest discipline is to keep drip feeding in as much as you can, as often as you can. Because the stock market is currently on sale.
The second option – and this won't be for most of us – is to cherry pick sectors or regions and buy or top up holdings progressively as the stock market goes on sale.
Managing investor behaviour at times like this is important, and maintaining the long term view will keep investors from crystallising losses when things will inevitably bounce back in the future.