Stock markets peaked in late December of 2021 and it has been all downhill for over 6 months since then. Nearly all asset classes have taken a plunge as the everything bubble has burst:
S&P 500 -18%
Bitcoin -41%, (-65% from the November highs)
Cannabis Stocks (MSOS) -53%
Energy is one of the few asset classes that has appreciated in value over the past 6 months. Crude oil is up 15%, while natural gas is up around 60%. While this may represent an investment opportunity and place to store wealth, it has translated into higher prices at the pump, higher home energy prices, and negatively impacts consumer spending, the key driver of the economy. Higher energy prices have largely been driven by the war in Ukraine and U.S. policies to move away from fossil fuels.
While markets have been tumbling in 2022, we have seen a significant bounce over the past week:
S&P 500 +4%
Cannabis Stocks (MSOS) +12%
Uranium Stocks (URA) +10%
ARK Innovation ETF (ARKK) +9%
This has many investors questioning whether the markets may have bottomed. Is this the start of the next bull cycle or just a relief rally or dead-cat bounce?
The majority of analysts that we track are expecting more downside ahead and we agree that economic data such as GDP growth is likely to remain dismal. Market participants are expecting continued rate hikes to negatively impact the economy and this outlook seems certain. The FED is expected to hike rates another 75 basis points next week and on July 28th we will officially find out if the U.S. is officially in a Recession, marked by two consecutive quarters of declining GDP.
The Atlanta FED’s model is currently predicting a 1.6% decline in GDP for Q2, well below consensus estimates. If GDP does come in positive, this could add further fuel to the current stock rally.
But markets are forward-looking by 6 to 18 months and may have already priced in the next several months of rate hikes and weak economic data. The current rally could be in expectation of the FED pausing rate hikes or even pivoting and reducing rates again at some point in the coming months. If that is the case, the current rally could be sustained and more than a temporary bounce. Markets tend to overshoot during both rallies and corrections, so we think value investors are starting to bottom fish.
To be sure, we expect there will be significant volatility over the coming months. But in our view, the odds that the markets have bottomed are significant enough to start dipping our toes in the water and buying in small tranches. We want to keep cash on the sidelines in case we are wrong, but valuations have fallen from record multiples (price to sales and price to earnings) to more reasonable levels. The S&P 500 P/S is down from 3 to 2.4 and P/E is down from 45 a year ago to around 20 today. The popular Shiller P/E is down from 40 in December to 29 today.
With most analysts bearish and many predicting an economic crash ahead, we think the contrarian view that markets may have bottomed is interesting to consider. The employment market remains very strong, real estate prices have held up very well and we are seeing prices for gasoline, building materials, and commodities falling from recent highs. Economic data can get worse in the months ahead without stocks falling much lower from current levels.
Again, we aren’t absolutely convinced that the bottom is in, but we also aren’t trying to time it exactly. We think that valuations have dropped significantly enough to start nibbling on quality companies in oversold sectors that we view as having greater upside potential than downside risk over the next few years.
The Nasdaq is showing some signs of bottoming on the technical chart. We have seen higher lows and higher highs since mid-June, the RSI has bounced after approaching oversold levels and still has room to continue higher and the index pushed through the 50-day EMA this week for the first time since March.
We ultimately want to see the Nasdaq break above the 100 and then 200-day EMAs, the latter of which is aligned with the top of the trend channel. We aren’t waiting for this move, but the Nasdaq breaking back above 13,000 would signal a trend reversal and confirm the bottom in our view.
When large numbers of investors have thrown in the towel and sentiment has become very bearish is when the greatest investment opportunities are presented. We’ve all heard the sage advice about buying when there is blood in the streets and others are panic selling, but the real challenge is actually putting this philosophy into practice. Most investors only want to buy when assets are rallying to record highs and end up selling near interim bottoms.
Nicoya Research portfolios have taken a hit with the broader markets in 2022, but we are coming off record gains over the past few years. We took some profits in 2021 but held other positions into the current decline. We have increased exposure to cryptocurrencies in recent weeks and will be looking to also increase exposure to quality tech stocks, energy companies, cannabis names (US MSOs), and select mining stocks. We have already seen gains of 50% or more in several of our current positions over the past week alone.
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