There has been little to like about the markets so far in 2022. The two major asset classes, stocks and bonds, are both down. Of the two, I would contend it is the bond market that has greater challenges ahead and has exhibited more prolonged weakness dating back nearly two years.
However, having managed both asset classes, I recognize it’s always the stock market that gets the most attention.
The stock market, as measured by the S&P 500, has declined about 16% from its early January highs and is in correction mode, defined as a drop between 10 and 20%. Perhaps more concerning, the average S&P 500 stock is 25% below its own 52-week high. That statistic causes more concern for investor portfolios, with the next question being: How much more could the market drop?
Calling stock market bottoms, or even tops, is an exercise in futility. The batting average for the average Wall Street strategist is terrible. The current weakness is most related to the last 6 -12 months of higher inflation and rising interest rates, and what that will ultimately do to the economy and profits.
Recessions are inevitable and part of long-term cycles. Forecasting them is treacherous too. However, for what it’s worth, we rarely get recessions when the employment market is as strong as it is today. In addition, the overall condition of both the consumer and corporate balance sheets is quite healthy.
We are about three quarters of the way through first quarter profit reporting season. The news has erred on the good side, both for what has taken place and the forward guidance from management teams. The concern, which translates throughout the market, is the inflationary impact of higher prices and what that can do to sales, cash flow, earnings and margins.
Favorable sales growth, which is currently growing more than 10%, has a direct correlation to profit and cash flow margins remaining above average. In short, the micro forces of company performance remain compelling. The macro forces, however, notably inflation, interest rates and the Federal Reserve are winning the “tug of war” currently between the macro and the micro.
From our long-term perspective, the micro inevitably prevails for individual security selection for adding value beyond the near-term discomfort of intra-year stock market declines.
The following chart reinforces that the average intra-year decline has been about 13% for the last thirty-five years. Of course, with averages, there are both years of significant and not so significant declines. That is why the constant focus on the strength of a company’s balance sheet, its cash flow generation and its overall business competitive advantage versus its peers is even more critical in 2022. That is the place to focus one’s efforts for long-term success, in our view.
S&P 500 Calendar Year Return vs. Largest Intra-Year Decline
Source: Strategas, Bloomberg. 2022 data YTD as of 5/9/22.