Beware the big bad bear
Stocks go up, stocks go down. And whoever observes share markets on a daily basis fully well knows there are all kinds of variations in between.
One thing remains, however, and that is that writings about the share market read differently when placed in a different context.
The story below was written two months ago. It's not an attempt to predict what happens tomorrow or next week.
It's pointing to a broader picture framework that I believe remains as important as it was earlier in the year, irrespective of what happens in the short term.
It happened last week
"How come so many investors got wiped out during the GFC?", said one trader. "I don't understand. Surely everyone has a pain threshold. Surely at some point every investor goes 'enough is enough'?"
Yeah. If only it were that simple. If only he was there, he wouldn't be asking the question.
The problem, I responded, is that bear markets are a process. Despite assurances from some chartists and the usual Cassandras, nobody really knew what exactly was the problem, how long it would take and how bad things would turn out.
It's only human to start tapping into the internal optimist once that first -10%-20% is on the boards. After all, history shows market corrections of -10% are not that unusual, and even -15% or -20% is simply par for the course. It happens.
And as everyone who has been in the market long enough knows, such pullbacks are healthy; they create buying opportunities.
Hence, you don't sell when your portfolio has been shaken and rattled. It is but a flesh wound! You hope you have enough cash on the sideline and you start planning for your next allocations. Alternatively, you keep on cashing in the dividends and tell yourself it's now a waiting game. Better times, surely as day follows night, shall arrive.
Again, history backs up that statement. Every single disaster, every single 'lost decade', every bear market has ultimately created a fertile environment for the next bull market. There's simply no denying the fact.
But during the GFC investors did not get wiped out because eventually all the world's problems -and they were severe at the time- got resolved and shares embarked on their next leg upwards.
Investors got wiped out because of what happened in between. Share market indices, on average, lost half of their peak-2007 value. That's down -50%. And the process took about 16-17 months to complete (if we don't include the August panic sell-off in 2007).
In between we had savage sell-offs, rallies, a long pause, more sell-offs and rallies, and ultimately the selling wouldn't stop until everybody was exhausted, desperate, desolate, and utterly destroyed; at the very least mentally.
The Bottom Line And The Damage Done
Back in the days, FNArena had been on the bearish side since mid-2007. We had cautioned about the banks, persistently and relentlessly, next about the bubble in oil and then warned about the commodities sell-off that would pull BHP Group ((BHP)) shares to $20 (from $50 in late 2007).
My biggest frustration, however, was that we still experienced the loss of many a subscriber once the bear market had ended.
The loss of -50% and more was simply too much to bear for many.
Sure, they read the warnings, but many other experts stuck with optimism, and there always are plenty of reasons not to sell: capital gains taxes (if you own the shares for a long time) are but one of them. The need for regular income could be another reason.
The bottom line is: if a professional investor gets it wrong, he/she might lose their job or a few clients, but if you are managing your own money, the consequences of staying the course while keeping your fingers crossed and hope for a smooth transition can be no less than devastating.
Or as one US expert reminded his clientele recently:
-To compensate for a loss of -40% you need a subsequent gain of 67% just to square up again
-To compensate for a loss of -50% the total portfolio needs to double (up 100%)
-To compensate for a loss of -75% the subsequent gain needs to be 300%
Let there be no misunderstanding: I am by no means making the forecast that the current bear market won't end until equity indices are down by -40% or more, but it is my observation most investors, and market commentators, are underestimating the challenges and headwinds that are rapidly building.
Are Recent Experiences Relevant?
The general comfort with this year's volatility is probably related to the fact that recent experiences with market meltdowns have been rather brief and not too painful in the bigger scheme of things. Let's face it: for a number of weeks the situation in 2020 looked awful, but the share market outcome was everything but.
The way our brains operate, we draw more confidence from such events, as we do from stabilising or rising share prices. Risk only ever seems tangible and real when asset prices are melting down. This is, of course, all about perception.
One cohort of market participants that has received a very harsh lesson in 2022 are the many young, gung-ho investors who joined in with full gusto following the initial covid-meltdown in 2020. All they ever knew was 'buy the dip', and if a share price dips lower, you simply buy more!
Who knew investing was that simple?
The story since late last year, which started mid-year in the US, has been that former market darlings and popular new era-stocks have simply kept sliding south. Eventually, of course, there's no money left to allocate into the next 'dip'.
We must now fear that many of those investors -currently in hibernation, licking their wounds- will not return anytime soon, if ever, as the capital destruction has been nothing but ginormous with popular stocks deflating by -60%, -70%, -80%, and more.
In Australia, we have only seen a smidgen of this process, but some of the local covid-beneficiaries and technology stocks have been hit just as hard. Kogan ((KGN)) used to be a $20 stock; it lost about -75% since. The damage from the January 2021 peak has been similar for shares in Redbubble ((RBL)).
And if you got carried away with the momentum in Mesoblast (MSB) shares back in 2020 and hung on in the hope things might get better, you're essentially looking at the same proposition.
My own anecdotal observations were confirmed last week by Gemma Dale, Director of SMSF and Investor Behaviour at NABtrade. Many of the younger investors have burned their fingers, badly (as we all knew would happen eventually) while many among the older investors are now happily loading up on energy and commodity stocks.
Bring it on! Happy Days!
No more heroesOther investors, I can add from personal insights and from questions received here at FNArena, are buying the dip in stocks they thought they could never afford.
My worry is these investors are essentially applying the same buy the dip strategy as the youngies were doing, just in a slightly different format. Are they the next ones to receive a harsh lesson?
This is what my story today is about: it's not a given, but it most definitely is a genuine possibility.
Today, I think, is not a time to allocate extra funds into the share market.
At the very least, it seems but prudent to account for rising risks. If you do ride the momentum in commodities, do it with the understanding that it won't last. Think about what happened in 2008.
If you are looking to buy industrials and financials at beaten-down prices, be patient – be patient for longer. Don't automatically assume a share price that already has been beaten-up cannot go much lower.
Remember that old joke? What's a share price that has fallen by -90%? That's a stock that first fell by -80%, and then halved in price.
Today's prime worry is the military conflict and international sanctions following Russia's entrance into Ukraine might be obfuscating the real challenge facing financial markets in 2022. That challenge relates to the fact the Federal Reserve, and potentially other central banks too, is now forced to tighten and to continue tightening as inflation is sticking around in high numbers, threatening to grow roots and stick around for longer.
The fact the Federal Reserve is also hinting at running down its balance sheet, effectively starting to sell fixed income assets, as Jay Powell channels Paul Volcker in the 1980s, should be very frightening indeed!
It appears the investment community has too easily forgotten that the bear market of late 2018 only ceased when the Federal Reserve announced it would stop tightening. Back in 2020 it was another (massive) liquidity injection combined with (massive) government stimulus and a new horde of young investors that turned an ugly situation into a brief blip in an ongoing uptrend.
None of these ex-machinas are likely to be around later this year. Sure, the Federal Reserve might ultimately reverse course, but it'll only happen after another market meltdown, and if inflation is still high, one wonders whether that is actually still good news?
Global growth is decelerating. This is nothing unusual. But what is unusual is the Federal Reserve will be tightening in a slowing environment, and sticky, high inflation is likely to keep the pace of tightening up, while also creating a barrier to pause. Bond markets have started to worry already this combination might push the US economy into a recession – potentially, but most certainly into slower growth.
How much slower?
We don't actually need to see negative growth for things to get a lot worse in equity markets. Merely the expectation this could be the outcome is probably sufficient. The next shoe to drop, most likely, are earnings expectations. Last year, many an investor became worried way too soon as continuously rising earnings forecasts provided solid support. Won't be long, I worry, that dynamic starts moving into reverse.
The yield difference between US 2-year and 10-year Treasuries is shrinking with the difference in March less than 0.30%. For the yield to be inverted, widely seen as a market signal the next economic recession is in the making, the yield on the 2-year should exceed that of the 10-year. This is not a perfect indicator. Nothing is. But investors will be watching this closely.
Simply put, I have come to the view that accumulating risks are a lot higher than what is currently suggested by day-to-day price action.
I think investors at the very least should start thinking about a recession-like environment and whether the companies they own might thrive, cope or falter under the pressures of slower growth and a reluctant consumer.
Names like Coles ((COL)), Woolworths ((WOW)) and Metcash ((MTS)) should once again be on the radar, if they aren't in the portfolio already, as well as Amcor ((AMC)), Orora ((ORA)), CSL ((CSL)) and ResMed ((RMD)), to name but a few.
Because 2022 is a lot riskier than the prior two years, as well as most years before that, and not simply because the opening months have already injected so much volatility.
The above is not a prediction, it is merely a reminder that in 2022 worse-case scenarios should be on every investor's mind.
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