Things are clear as mud

This is the weirdest market and economic environment of my career. Michelangelo would not be able to paint a clear picture of everything. He must always be wary of people who have strong opinions about the future, but perhaps never more so than now.

Here is my best attempt at explaining where we came from and where we are today.

This year has been all about inflation and interest rates. Rising inflation killed stocks and rising interest rates killed bonds.

Consumer prices began to take off in the spring of last year as the economy came off life support and began to run sprints. There was much debate about whether or not the increases were transient. They were not, and we have seen nothing but further acceleration, with the most recent reading reaching a dizzying 9.1%, the highest number in over forty years.

To help ease pressure on prices by cooling demand, the Federal Reserve has raised rates four times this year with the intention of continuing to raise them until prices decline.

Rising prices destroyed consumer confidenceand the fall in share prices destroyed investor sentiment. house builders they are destitute, with sentiment falling in July by the most in 37 years, except for April 2020.

The stock market generally looks to the future, but let’s be honest, it doesn’t always get it right. It didn’t do a great job spotting inflation, for example.* The IPC first broke above 5% in May, and the S&P 500 didn’t peak until January. With stocks well below their lows, I wonder if they are discounting less bad earnings or peak inflation. Orrrr, maybe this is just a dead cat bounce, and I’m trying to find meaning where there isn’t.

Banks kicked off earnings season by telling investors that consumer and commercial credit was doing just fine, never better in some cases. But nearly all told investors they are bracing for a slowdown. Then we heard that AT&T reduced targeting and retailers like Walmart did the same. Snap put out a guide and we braced ourselves for shock by hearing what Google and Facebook would tell us about the state of the ad industry.

Stocks stopped going down in June and really started to rise last week after we received some strong numbers from companies that shared their second quarter results. Google reported 13% revenue growth, the slowest since 2015. Not great, but not as bad as investors had estimated, with the stock more than 30% below its highs. Apple, probably the biggest company in the world, reported record numbers for its June quarter. And travel companies have told investors they see no signs of a slowdown.

So who do we listen to? Perhaps the banks are being conservative. Perhaps retailers blame inflation when they mismanaged their inventory. Maybe Snap just can’t monetize its users, and advertising, one of the most cyclical areas of the economy, is fine. Google’s 11% revenue growth in that segment would seem to indicate so.

This may sound obvious to the point of absurdity, but the easiest way to describe what’s going on right now is that some companies are more affected by macroeconomic conditions than others.

Based on what we’ve heard from earnings calls and based on what we’ve seen in the labor market, it’s hard for me to say that the economy was in a recession for the first half of the year, even with GDP falling by two consecutive months. quarters.

The big questions now are: has inflation peaked, are we heading into a recession, can the Fed pull off a soft landing, and what has the stock market already priced in?

Let’s take this one at a time.

We have started to see signs that inflation is coming down, although the numbers have not budged yet. Commodities are arriving from everywhere; Wood is down 60% since March and national average gasoline prices are down 16% since mid-June. That’s all well and good, but on the other hand, house prices are still high and nominal wage growth It hasn’t slowed down at all.

In the r-word, this is the Rorschach of all Rorschachs. I happen to think that, again, looking at the labor markets and listen to earnings callsit’s hard to argue that we were in a recession during the first half of the year. At the same time, it could be argued that a recession is looming. And given that the Fed is actively trying to smooth demand, it’s probably best not to think about this too much.***

Can the Fed pull off a soft landing? Three months ago, I would have said no way. Now I think there is a possibility. There is a debate about what the Fed said last week versus how the market interpreted its words. The S&P 500 soared 5.4% in the three days since the Fed spoke, led by Neel Kashkari. tell:

“I am surprised by the interpretation of the markets,” Kashkari said in an interview. “The committee is united in our determination to get inflation back down to 2 percent, and I think we will continue to do what we have to do until we are convinced that inflation is on track to get back to 2 percent: and We are a long way from that.”

In the 164 days from the high of January 4 to the low of June 16, the market priced in a lot of bad news. The S&P 500 fell 23%, the Nasdaq-100 fell 33%, high-flying stocks lost 90% of their value, new listings dried up, cryptocurrencies exploded, and investor enthusiasm plummeted.

Over the last couple of weeks, the news continued to get worse****, but stocks stopped falling.

It has been 209 days since the S&P 500 peaked and 46 days since it bottomed. The question now is, was that the down, or just a down?

Some of the best performing stocks in recent weeks are the ones that have been hit the hardest over the past two years, as you can see in the chart below. And some of the worst performing stocks in recent weeks are the ones that have performed best over the past year.

People might say that this could be indicative of a junk rally. I haven’t seen any evidence that market funds have to adhere to a certain set of principles, but in any case, this rally has been quite broad.

In short, I am confused. The best thing to do now is to stick to your general investment philosophy, whatever that may be. And if you don’t have one, find one soon.

The markets are not always right, as mentioned above, but they are definitely better than your stomach at pricing risk. Don’t let your big decisions be motivated by fear and greed. Listen, I’m human, I’m more optimistic now than I was in June, but you wouldn’t know that by looking at my portfolio. I already know it what I’m going to do if the market goes down or sideways. In other words, try not to get distracted by the stock market.

I have zero confidence in my ability to predict the future, but if you forced me to give an opinion, a guess, it would be this; investors are too optimistic after being too bearish. A couple of weeks ago, Amazon had wiped out four years of profit. After falling 45% from its peak, the stock was back where it was in 2018! Now Amazon and others like it are bouncing on backward-looking earnings numbers, indicating investors’ previous forward-looking estimates were too bearish. Decent earnings are turning out to be good enough.

The future is never clear, but sometimes it’s more confusing than others. Now is one of those times. Fortunately for you and me, seeing the future is not a prerequisite for being a successful investor. Focus on what you can control; the rest will eventually take care of itself.

*I guess you can point to the high-flyers that peak at february 2021 as a sign that they did, but again, inflation was above 5% for eight months before the broader indices peaked.

**Really

*** I can go 2,000 words deep into this one, but this post is already getting hot

**** I can spend another 2,000 words on this one. Some companies are doing well, some are struggling, some are dying. Some think that inflation has peaked, others have not. Some think the Fed is preparing to turn, others think they are still aggressive.

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