2nd Half of 2022 Market Outlook Part 1 – Where Do We Go From Here | Stock Talk Podcast
First things first. We have had a big, big rally in stocks over the last six weeks. We thought this was likely back in late June and early July. We published our thoughts with our July 1st video, “Opportunity Knocks early.” However, from here, the indicators we watch say we should expect a couple of months of waffling before the market decides its true intention, which is potentially upward. Ok, onto this video.
Many economists and strategists were early to make comparisons to the 1970s. How early? Some people have been parroting this stuff for over five years. See the writings of hedge fund icon Ray Dalio of Bridgewater. He started this as early as 2017. Has this analogy helped anyone who has been investing for the last five years? No. Well, not until the first half of 2022.
I’m part of Generation X. We were born between 1965 and 1980. Our generation vaguely remembers the 1970s. We remember gas lines as children and recall our parents being mad about not getting paid 15% on their CDs anymore. We are part of what I have deemed the “irrelevant generation.” Others are more kind, calling us a transitional generation.
There are about 65 million Gen Xers in America. We are wedged between the massive, but now declining Baby Boomer demographic, who is older than us. On the other side is the Millennial and Gen Z Tsunami, whose numbers total almost 140 million combined. This group, under the age of 45 to 50, will take control of America’s economic and political path over the coming decade. It’s just math. It’s a numbers game. As Thanos said in Marvel’s “Infinity Wars,”… “I am inevitable.”
Gen Xers grew up as children in the 1970s and mid-1980s. We grew up in a time of shifting societal values. We were dubbed the “MTV Generation” growing up on a new media technology, cable TV. We grew up on ESPN, CNN, and TNT. We were the first generation to grow up on Video games for entertainment and computers for education. However, we were characterized by our elders, baby boomers, as slackers and cynical. Stop for a minute and think. Does this sound familiar to today’s talk about Millennials and Gen Z? Just saying.
Like all generations, many of our influencers were new music talents. Elton John and Led Zeppelin in the ’70s, followed by disco, punk, and heavy metal in the ’80s. Politically, we experienced the last days of communism and a transition, globally, toward capitalism, democracy, conservatism, and free market economics. I know you are asking yourself, Chris, how does this all connect? Where are you going with this?
The first half of 2022 is behind us. It was abysmal in the markets. As our team had expected, we suffered the first true correction since the Covid crash in the first quarter of 2020. However, we also extended that downward to the first -20%, bear market drawdown in years. We didn’t expect that severe of a first-half downturn. But the question is now? What’s in store for the second half of 2022 and the first half of 2023? Are “THE” lows in for 2022? And is it really a replay of that ’70s show, and if so? Where are we in the ’70s?
I am Chris Perras with Oak Harvest Financial in Houston, Texas, and welcome to our weekly stock talk podcast, keeping you connected to your money. Before we get into this week’s topic, the first part of what does the rest of 2022 look like? Or let me steal from the 1970’s band Chicago, “Where do we go from here?” Please take a moment to click on the subscribe button and click on the notification bell so you will be alerted when our team uploads our latest content. Much of this and the next few weeks’ content will be part of a Friday, August 19th, YouTube live stream our team is doing on our second half market outlook. Take a moment and preregister if interested.
Are the stock market lows in for the year? Is this year’s correction and “bear market” decline behind us and in the rear-view mirror for good? Was June 16th the low for the stock markets for 2022? Those are the questions on almost everyone’s mind. Are the markets acting like it’s the 1970’s this year? Yes, a little, with both high inflation and negative stock market returns in the first half. What year? 1974 to be exact. The same year, Elton John released his classic, “The Bull is Back.” Well, his title was a bit different. It had a different 5-letter “B-word.”
And while no one, including myself, can say so with absolute certainty that yes, the lows are in for the year, we first presented our case for this on July 1st, with our video release, “Opportunity knocks early.” The data has been saying that “yes,” there are good odds that it was “The Bottom.” Viewers and Listeners, unless you think we are on the verge of another 2008 Great Financial Crises or 2000 DotCom bubble collapse, which we don’t, the data is aligned and saying the worst is over. The correction and bear market of 2022 is in the rear-view mirror.
I remind you that while we do think June 16th was THE low for the year, 2022 still does not look like a V-bottom year. We expect a few more months of uncertainty and volatility in the overall markets through the 3rd quarter. However, we expect more monthly volatility throughout year-end. It could be much calmer than the first half. In addition, we expect the “buy the Dip” institutional crowd to re-enter the market on moves down of only 3-5%. With leading inflation indicators currently headed south, If the Fed chooses not to ruin the 4th quarter consumer party, the S&P500 could recover to nearly flat on the year in the range of 4650-4750. Exiting the year with positive momentum and sentiment on the way to a 5100+ first half 2023 high. All these moves would be fairly standard for a mid-term election year.
Frequent viewers and listeners will recognize many of the charts that I’ll be using as background material, but here goes. Let’s start off this presentation talking technicals and charts. Let’s talk about the chart of the S&P500 first. That’s the one everyone cares about. Remember that the price of any asset is just supply and demand. Yes, investors weigh thousands of variables at any given time but in the end, regardless of the Fed, regardless of politics, earnings, volatility, wars, famine, and regardless of inflation, price is determined by supply and demand. Here is a monthly chart of the S&P500 going back 23 years. There are two moving averages on the chart. The 20- and 50-month MVAs. Since the Great Financial Crisis in 2008/09, the market has fallen to its 50-month MVA 6 times. The most recent being June 16th of this year. Each time, including the most recent, the S&P 500 has regained its 20-month MVA within three months. The S&P500 is now above both those levels. . It closed the month of July strongly and quite bullishly.
As one can see, unless you think we are in GFC round 2 or the Dot.com bubble part 2, history, this cycle would say we can rally and approach a flat year for 2022 by year-end. Let’s call it 4700-4750. Beyond that, a move on to new all-time highs in the first half of 2023 would be likely. This would be In-line with our 1st half 2021 outlook titled “curb your enthusiasm yields to a bull market buy,” we released late last year. We, currently, could still see the S&P500 peak near 5100 to 5150 in the first half of 2023.
Take a look at the chart on the technology-heavy NASDAQ Composite. The picture looks very similar, and it should since the largest stocks in the S&P500 are now largely technology, communications, and internet consumer-focused. Much has been made that we are in the midst of round two of the internet bubble popping. This chart would say that statement is doubtful and highly questionable. I can make the same or better case that we are setting up like the 4th quarter of 1998, just prior to the last 18-month wave up in the internet bubble. How similar? In the summer of 1998, the Nasdaq swooned and tanked -35.65% in only four months, only to regain its monthly moving averages and head materially higher for another 18 months. Similarly, this year the NASDAQ composite tanked -35% in about six months and now has regained both its monthly moving averages.
The second topic, interest rates. Not the short-term interest rate the Federal Reserve controls, but interest rates measured in real-time. This one is “real interest rates.” Some people call this the TIPs spreads. Some people call this the real yield. This isn’t the one people talk about on TV. You add market pricing of inflation to the real yield or TIPs spread, and you get the nominal yield which everyone quotes on TV. You get the 10-year Treasury yield that is the starting point for most mortgages. This real yield is perhaps the single most important chart you will see. Why? Because the “real yield” is used to calculate equity risk premium, which translates almost directly into PE multiples in stocks.
Take a look at the 10-year real interest rate chart over the last 2 years. Let this chart sink in. Remember that the real yield controls the overall PE ratio of the market and for 2022 the PE of the S&P dropped from about 22x to around 16 times earnings at the lows. The market PE compressed about 27%, and the S&P500 dropped how much from peak to trough? A little over -24%. Almost the entire drop in the market in the first half was valuation compression.
The overall stock market went generally higher all of 2021. Throughout most of 2021, every speculative 4-letter tech name went higher. Not coincidentally. This ended when the Federal Reserve started talking about tightening financial conditions in late November 2021. Since then, the 10-year real yield rose almost weekly until? Spot on June 16th, when the Fed announced their first 75 basis point increase in rates since November 1994. Since that meeting, the trend in real yields has been down, and the trend in the stock market has been? Up.
What have been the best performing groups since June 16th? The growth areas of the stock markets. Technology, healthcare, consumer discretionary, and growth at any price stocks as overall nominal interest rates have also declined. The worst performing groups? The short cycle value plays. Energy and materials. With so much of the S&P500 index weighted toward technology, discretionary, and growth areas, the overall market needs to continue to see at least stable real interest rates if not declining to continue its recovery in the second half of the year.
Our third topic, market volatility. Year to date, the volatility of all asset markets have made many retirees and other investors anxious while making short-term traders very happy. Short-term traders love quick and rapid moves. While presenting greater long-term investing opportunities, most retirees like gentler price moves. We previewed way back in November of 2021 that the first half of 2022 was likely to be a sloppy choppy, volatility-filled mess. We couldn’t tell you exactly why, but the tea leaves said, “Curb your Enthusiasm,” which was the title of our first half 2021 market outlook. No one has that Wizard of OZ, perfect crystal ball. However, we do have some tools that historically work pretty well at looking forward.
What are those signs saying for the second half of 2022 when it comes to volatility? While still higher than most investors would welcome, our indicators are saying overall market volatility for the second half should be lower, not higher.. Hopefully, music to investors’ ears and to those watching their accounts too frequently.
For the first time since last November, there are hopeful signs of the volatility clouds clearing. Our team often talks about future volatility in the markets, not the spot VIX index that most others reference. We focus on forward volatility, months into the future. It is a real, tradeable tool and financial instrument, not a math calculation like the Spot Vix. These forward volatility tools are tradeable and are used to hedge big institutional portfolios. Take a look at the forward volatility chart four months out in the future.
As you can see, since late fourth quarter of 2021, this chart has been up and to the right. It made higher highs and higher lows each wave up, until? Yes, that same week in June. June 14th to be precise, when it peaked. Forward volatility stopped making higher highs for the first time in 10 months. And then, in mid-July, volatility broke to the downside. This is bullish. No, this doesn’t mean volatility is gone for the rest of the year. It doesn’t mean we immediately return to boring economic cycles and bull markets like 2017. However, what it should mean is that future volatility spikes will likely be sold, and dips in the stock market in the 2nd half will be bought.
What do we think would signal the “all clear,” volatility will collapse, and FOMO, Fear of Missing Out, has returned? Look no further than the “Move Index.” We’ve discussed this one many times in the past under the topic of “Collateral Damage.” Remember, the Move Index is essentially measuring Treasury bond volatility like the VIX measures equity market volatility. Take a look at the recent chart on bond volatility.
Notice, unlike future stock volatility, the MOVE index has not yet broken its upward channel to the downside. While it does look to have peaked July 4th weekend, at the end of the 2nd quarter, it has yet to start a pattern of lower highs and lower lows.
Why is this important? Remember that a large number of institutional investors, like hedge funds, manage money on margin, leveraged, using borrowed money to magnify returns. To borrow money from their prime broker, they must post assets as collateral. The safest and supposedly least risky and least volatile collateral are US Treasury bonds. If an investor’s collateral is moving around in a volatile way along with the asset they are invested in? The margin clerks call and force them to take their positions down. They force them to sell. They force them to raise cash whether they want to or not. The force them to sell at the lows regardless of their convictions.
We’ve seen this selling show up as a contrarian bullish position in their cash holdings. Institutional cash levels have risen to 6.1% up from under 4% last November when the markets topped. That’s the highest level since October 2001. Take a look at the chart from Merrill Lynch tracking cash levels in big institutional accounts.
Yes, 6.1% doesn’t sound like a lot of cash to most people. However, you have to remember that most of these institutional managers’ performance is being compared against the S&P500 index returns. The S&P500 index carries no cash. None. Zero. Ever. Vanguard and BlackRock’s S&P500 index ETFs and mutual fund’s sole goal is to mimic the daily performance of the S&P500 regardless of whether the price is up or down. Each day, Every day. The only way they do that is by being 100% invested every day regardless of inflows or outflows. So, when the markets start to reverse higher. These other big active managers, carrying 6% cash, will almost inevitably lag the market’s overall returns. Guess who doesn’t like that. Marketing and sales departments who sell only investment performance, not comprehensive financial planning, tax planning, or hands on retirement planning. And guess what emotion starts to creep into these portfolio managers’ feelings? Yes, FOMO, the fear of missing out.
Was June 16th “The Bottom” for 2022? Time will tell. Time measured most likely in month’s not days. Most likely into September and October. But as we have tried to present since our July first video titled “Opportunity knocks early,” many of the tea leaves that signal green shoots for stocks have finally started to appear after a treacherous first half of 2022 beginning. But we warn you again. Straight lines higher in the markets are unlikely, yet. Next week, Part 2 in our series on our second half outlook.
If the ongoing market volatility is making you feel uneasy, give us a call, and schedule a meeting with an Oak Harvest advisor. Our team does have insurance-based tools that do not have the volatility of public markets. However, we remind you, that these investments may also have lower long-term expected returns.
At Oak harvest, we think our clients are best served by us helping them plan for their future needs, instead of focusing on the past. The future and stock markets are always uncertain and that is why our retirement planning teams plan for your retirement needs first, and your greed’s second.
Give us a call to speak to an advisor and let us help you craft a financial plan that helps you meet your retirement goals. Call us here at (877) 896-0040 and schedule an advisor consultation. We are here to help you on your financial journey into and through your retirement years.
I’m Chris Perras, and from everyone here at Oak Harvest Financial Group, have a blessed weekend.
CFA®, CLU®, ChFC®
Chief Investment Officer, Financial Advisor
Chris is a seasoned investment professional with over 25 years of experience working with some of the most successful money management firms in the world. Chris has made it a point in his career to adapt as the market landscape changes, seeking to utilize the appropriate investment strategy for a given market environment. His transition from managing billions of dollars at the institutional level to helping individuals and families retire is guided by a desire to see first-hand the impact he is making in the lives of clients at Oak Harvest.