Where is a Market Bottom?

It seems clear now that we are entering an across the board “Bear Market” marked by the Dow Jones and S&P500 indices nearing 20% losses from their highs. The Nasdaq has already fallen 31%. The question is where is the bottom?

The fact is no one can say for certain. We can only estimate based on historical reference, company valuations versus earnings, and ponder chart patterns for support and resistance levels. Truthfully historical reference is of little help because Central banks have kept interest rates artificially low to recapitalize banks following the 2008-2009 mortgage debacle. A major portion of stimulus money intended to drive growth went into pushing financial asset prices higher. Company stock valuations rose to 40+ Price/Earnings ratios on big cap tech, 60-100+ P/Es on speculative growth, and 30+ P/Es on certain consumer staples and utility companies far surpassing the 15-20% historical, average market P/E. These multiples are now being recast with the anticipation of rising interest rates to combat inflation. High energy prices, continued supply chain bottlenecks, and fallout from the Russian Ukraine war could also mean a recession will follow in late summer or early fall. And this despite the $1.5 trillion infrastructure stimulus spending package rolling out to repair and improve airports, bridges, and highways.

Complicating inflation pressures and economic clarity about a bottom is the fact the Fed has been purchasing treasuries and mortgages that offered yields too puny to attract private investors. Now with $9 trillion on their balance sheet the Fed must push interest rates high enough to replace themselves (as buyers) while losing value on every bond they continue to hold. Surely this will entice the Fed to move more quickly to avoid greater losses. But at what effect on the capital markets?

As previously discussed, we are witnessing the end of a long-term debt cycle. Regular market cycles go from boom to bust but this time we are in uncharted waters because both stocks and bonds are currently overvalued leaving only cash as a temporary safe haven—inflation will still hurt the real return on cash, just less than the loss on most financial assets. This situation requires active risk management not passive rebalancing or simply getting out as either course produces a lose-lose outcome. Naysayers who argue just hang in there because missing the best 10 days of the market costs you dearly fail to understand the math of losses that it takes significantly greater returns to make up for a loss, or that missing the worst ten days of the market put you handsomely ahead of staying put (a 50% loss requires 100% return).

As a Total Return manager working to keep money compounding, we adhere to three financial principles: keep investment costs low, invest in the best opportunities, and combat risks to protect principal. During times of uncertainty risk management combined with a disciplined process to seize value, as Warren Buffett says: “when others are fearful,” is part of our investment process. For now, we are being patient partially hedged and sitting with ample “dry powder” to pounce when favorable prices warrant action. We are not there yet anticipating on-going supply problems, export disadvantage from a rising dollar, and fallout from both geo-political military and economic events on the horizon, but we will be before long.

Thank you for your trust and confidence. Enjoy your summer as we are Watching Your Money!