The Stock Market Halftime Show, 2022 (6 images for 6 months)
If you work in Corporate Strategy, you’ve probably put in some time at a management consultancy, declared allegiance to the Minto Pyramid, and mastered the Excel-PowerPoint arcade…
But at a time where the US, and much of the global economy, has been experiencing its worst start to the market since the Great Depression, it’s been critical to stay on top of these trends from a strategic perspective as well.
And recent indicators suggest there may be reason to be more optimistic about the future.
I hope the following 6 captures are useful:
- This has been the worst 1st half for a 60/40 portfolio since 1932
The 60/40 portfolio (60% stocks, 40% bonds) has been under pressure, as this has been the worst half for the S&P 500 in 50 years, and the worst start to the bond market since 1842… And those who prefer to keep their wealth in cash are losing 9.1% per year, factoring in the recent US inflation numbers.
2. Several macro-economic trends have influenced these market declines
The Bond market most recently peaked in 2020, the Stock market earlier this year, and it seems the Commodities market as well in recent weeks — which is the natural sequence of the intermarket cycle. But what’s behind these declines? Inflation has continued to rise, putting pressure on Central Banks around the world to continue raising interest rates (with exceptions such as China and Japan). Layoffs and hiring slowdowns are trending to levels not seen since early 2020 after the onset of COVID. Additionally, the US Dollar has been rising in value, now at its highest level in 20 years, which has put even more pressure on stocks.
3. The worst of the “Bear Market” may be behind us
“Bear Market” statistics are easy to come by: Stocks listed on both the NYSE and NASDAQ have been making more new lows than new highs for 34 consecutive weeks; The average NASDAQ stock has declined in value by 39% from the most recent peaks; The median stock across the market has declined by 26%, as exhibited by the “Value Line Geometric Index”, which is now at a major inflection point as shown in the chart below. When looking at the stock market, the “Principle of Polarity” states that once a resistance level is breached, it changes nature and becomes support the next time it’s approached… and we’ve approached that level. How should we be thinking about this?
From a completely different angle, corporate insider buying has been soaring to levels only seen 3 times in the past decade (late 2015, late 2019, and early 2020): Does this suggest that CEOs and other insiders are seeing better-than-expected earnings ahead now that Q2 earnings season is upon us? Does this suggest they believe their companies’ stocks are undervalued? These are questions we should ask ourselves when thinking about this market.
4. The next China “Bull Market” may already be underway
Bull Markets have a tendency to hit the ground running pretty quickly… Is this what’s happening in China? While the largest companies on the NASDAQ have been declining for months, the “NASDAQ-y” companies in China (like Alibaba and JD.com) have been climbing significantly, along with more traditional players in insurance, banking, and oil & gas. But why? Well, China had positive GDP growth in both Q1 and Q2 (unlike the US); its inflation is closer to 2% (vs. 9% in the US); and China’s Central Bank is expected by many to deploy more economic stimulus in the near-term. On the other hand, it seems like China headlines almost exclusively focus on continued COVID-related lockdowns. How should we be thinking about this part of the market?
5. The future leaders of the market may have already begun to “run”
A lot has happened in the past 2 months, from May until now. While most headlines have focused on the S&P 500 (SPY), global markets as a whole (ACWX; global minus US), and emerging markets as a whole (EMXC; emerging minus China)… there’s been a more positive shift in other pockets of the market, such as Chinese internet as just mentioned (KWEB), biotechnology (XBI), tech innovation (ARKK), and companies that have recently come public (IPO). Many wonder whether these recent uptrends have promise, or if they’ll ultimately decline again and disappoint. How should we be thinking about these parts of the market?
6. The companies that will continue to run will likely reveal themselves over the coming quarters (if they haven’t already)
The Russell 3000 is an index that delineates US-listed stocks by size, and I have been following the Russell 2000 (the largest 2000 companies after accounting for the first 1000, so #1001–3000) at this point in the cycle. These “small caps” range in size from $240 million to $4.6 billion… and given some of the upward trends these past 2 months, many have been honing in on innovative tech companies that fit the bill, and even more specifically, those that are enterprise/B2B (higher predictability than consumer) that serve customers across industries (less affected by industry-specific trends such as fin-tech or health-tech). For the first time in a long time, B2B software small caps are being valued by revenue growth with some consistency (see the yellow line in the chart below).
Many market participants may say this is a paradox, that revenue shouldn’t be a valuation anchor, which instead should be profitability or free cash flow, which is fine. We should indeed look under the hood to see which of these types of companies are in healthier positions as it concerns cash and a path to profitability, especially given the recent economic climate.
The companies above represent trending B2B software small-caps, serving customers across industries, and as exemplified by their valuation ranges over the past 52-weeks (see the blue bars), have been one of the hardest hit groups from their recent highs, averaging 71% value lost (stock price declines). On the other hand, with the momentum that seems to have picked up in recent months, some of these companies may have already bottomed, signified by an average of 29% value re-constructed (stock price increases from the lows, as of COB July 15). Which of these small caps are likely to emerge as the market’s future leaders? How should we be leveraging this type of thinking for other asset classes and areas of the market?
So… what’s my view? It’s simple, boring, and unoriginal: Both companies and investors alike must conduct thorough research, believe in your convictions if they’re well founded and strongly held, and above all practice good risk management.
Best wishes to everyone as Q2 earnings marches on into next week, including heavy hitters such as Alphabet, Microsoft, and Amazon.
