Financial conditions are tightening fast, global manufacturing activity is softening, and consumer and business confidence indicators are tanking. It's the start of a bear market.Kameleon007/iStock
Every correction, crash and bear market in stocks is a gift in disguise.
Give in to the panic by hitting the sell button and you can manifest ruinous losses. But treat it as an opportunity and you can set up years’ worth of returns.
Generally speaking, these are the kinds of moments that shape one’s performance over a lifetime of investing in the stock market.
How long will the bear market last?
Buying the bear? Equity demand endured market pain
So, has the current market sell-off gone so far as to become one of those generational opportunities? At least on a market-wide basis, it’s probably too early to pound the table.
“The problem for equity markets going forward is that you haven’t seen the earnings impact just yet,” said Dennis Mitchell, chief executive officer of Starlight Capital.
Consider what has fuelled the losses in stock prices around the world this year. The MSCI All-Country World Index has dropped by 21 per cent, almost entirely as a result of falling valuations.
With central bankers desperate to contain runaway inflation, investors have had to rethink what constitutes fair value for stocks amid quickly-rising interest rates.
Wednesday reinforced the skyward trajectory of consumer prices and policy rates. U.S. inflation hit a new 40-year high, with June prices rising by 9.1 per cent from a year earlier, while the Bank of Canada caught Bay Street off guard with a 100-basis point rate hike – its largest since 1998.
The furious withdrawal of liquidity by central banks worldwide is largely responsible for wiping out US$26-trillion in global wealth from stocks and cryptocurrencies, James Hodgins, an analyst at Stifel Nicolaus Canada, estimated in a research note. Throw in the clobbering of bond and real estate values, and the toll rises to more than US$50-trillion, exceeding the wealth destruction over two years during the 2008-09 global financial crisis.
Think of the sell-off to date as the first phase of the Great Bear Market of 2022, Mr. Hodgins said. This alone will get many contrarians’ pulses racing.
The slide in U.S. stocks has brought the average valuation among S&P 500 Index companies down to about 17 times forward earnings estimates – not cheap by historical standards, but a lot cheaper than the start of the year, when trading multiples were north of 20.
“There is no doubt that the risk/reward profile has improved considerably since the start of the year given the extent of the carnage in this steep corrective phase,” wrote David Rosenberg of Rosenberg Research.
Historical market data backs that up. Following periods as bad as or worse than the second quarter was, when the S&P 500 lost 16 per cent, returns over the following year averaged 18.1 per cent.
But, Mr. Rosenberg added, “the ultimate low in this bear market is likely still ahead.”
Financial conditions are tightening fast, global manufacturing activity is softening, and consumer and business confidence indicators are tanking – all of which suggests a hit to corporate earnings is on the way.
“I think starting in this quarter, and certainly in Q3, you’re going to see a number of companies bring down their earnings forecasts,” Mr. Mitchell said.
A correction in corporate profits is likely to fuel the next phase of the sell-off, as the market digests worsening economic data and waits for signs that central banks are getting ready to ease up with rate hikes.
That suggests it’s too early to make a bullish market call and broadly buy the dip, as many strategists were advocating back in March, 2020, following the brutal sell-off sparked by the start of the COVID-19 pandemic. That proved to be a historic buying opportunity, as the S&P 500 soared by 75 per cent in the year after bottoming out.
At this point, it makes more sense for investors to pick away at positions in companies with decent earnings power in a recession, which is looking increasingly certain.
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