It’s Never as Good or as Bad as it Seems - Holdun

It’s human nature to focus on the most recent news and react to our present environment. Where we go wrong is our tendency to extrapolate this current environment out into the future, assuming it will last forever.

During the good times, we get caught up in the euphoria. We think things will last forever, and we find ways to rationalize even the most ludicrous narratives. (Lest we forget, people were finding seemingly justifiable reasons to pay millions of dollars for this NFT of cartoon rocks less than a year ago).

This masterpiece pulled in $1.3 million

NFT of cartoon rocks - 2022

This tendency to extrapolate works both ways. It’s easy to get caught up in the downward spiral of bad news and buy into the doomsday scenarios.

The imminent collapse of Fiat Currency, World War 3 and a Global Debt Crisis all become seemingly guaranteed outcomes when outlooks turn negative.

But nothing lasts forever, and the current environment we are in will not be the exception to the rule.

This too shall pass. While it may seem inevitable when you are stuck in the echo chamber of endless bad news, in reality, the apocalypse than the doomsday preacher would like you to believe.

So, where does that leave investors?

You’re Looking in the Wrong Direction

No need to regurgitate the negative news. It’s everywhere. This symphony of pessimism has led to considerable market stress, with stock and bond indexes down over 20% YTD.

But that is what has already happened. You get no special prize for regaling what is currently happening or what has happened in the past.

The stock market is a forward-looking machine, so you must align your focus accordingly. As markets fall, you should ask yourself, what does all this mean for the future? How will things look one, three, or five years down the road?

As prices fall, fear increases but so too does the future expected return. Present-day turmoil creates future opportunities. For those not of retirement age, 30% market declines should be met with open arms and viewed as buying opportunities.

Current Environment

This year, we have seen a resilient labour market continue against the backdrop of rising interest rates and surging inflation as business and consumer sentiment craters.

But once again, investing is never about the present moment; you don’t get rewarded for what has already happened.

Nil pois. Nada.

Instead, we need to use the available data to predict where markets will go from here.

While anything is possible, we have seen multiple signs that suggest markets are moving in the right direction.

  • We are seeing comments from the Fed that suggest we are nearing the end of the rate hike cycle. San Francisco Federal Reserve President Mary Daly stated, “We have to make sure we are doing everything in our power not to overtighten, and we can’t pull up too fast and say we are done.” This is a considerable change in rhetoric and provides a reason to believe that a peak in rates is not far off.
  • As discussed last week, Labour markets have remained resilient, but the payroll metrics that the Fed are most interested in are starting to roll over
  • Supply-side metrics such as shipping costs, oil, inventory, and commodity prices have already unwound from their pandemic highs
  • While demand side metrics have been slower to show signs of weakness, data such as ‘existing home sales’ and the ‘PMI index’ have come under downward pressure recently, which will help to elevate inflation pressure
  • This year’s pullback has pulled much of the excess out of the market. The forward 12-month P/E ratio for the S&P 500 has gone from 21 to 16. This P/E ratio is now below the 10-year average of 17.0

It may take some time for this data to truly be reflected in the CPI figures, as much of the housing and food adjustments will show with a lag.

You also have the obvious but overlooked reality that people continue to pay up because they can afford to pay up.

As you can see from this chart from Goldman Sachs, businesses and consumers are in unusually strong financial positions, with excess cash balances well above pre-pandemic levels.

Cash and Cash Equivalents, 2019 Dollars

Source: Goldman Sachs

The below, shows a more pronounced level of cash on hand relative to pre-pandemic levels.

Average Consumer Deposit Balances

Graph - Pre-pandemic balance Jan-20 - Sep-22

Like so many of the bullet points above, these trend lines for deposit account balances and cash on hand are plateauing and reverting, but both still remain in a stronger position relative to pre-pandemic levels. There will be more time needed for this to fully wash out, and there may be some more pain along the way, but this remains the necessary evil.

While getting caught up in the negative news echo chamber is easy, you must avoid simply observing the present moment and extrapolate your investment thesis from there. Observe the trend. This is what will truly determine the future direction of markets.

There will be no all-clear, and if there is, it will be too late to put your money to work.

The best we can do is observe the data to spot reversals of significant trends and invest accordingly.

Opportunities Ahead

For now, we remain in a ‘bad news is good news’ environment.

Of course, the extent of that bad news is crucial. Initially, this bad news will be positively received by market participants as an economic slowdown allows the Fed to take their foot off the gas in the fight against inflation, but at what stage does bad news simply become bad news?

Short-term risks remain, the fiscal and monetary fishbowl is gone, but the long-term picture continues to improve at current valuations.

As the legendary investor Stanely Druckenmiller once said,

‘Do not invest in the present; the present is not what moves the market’.

Stop looking in the wrong direction. What just happened won’t tell you what happens next.

The best investments are made in the worst of times.

Now is the time to take advantage of the current market conditions. To learn how we can help, simply follow the link below.