Finding the Market Bottom

WELCOME

First off, thank you to the many of you who constantly pushed me for this newsletter. This actually made me organize all the regular research I do for myself into a more cohesive form. I will continue to publish these on a monthly basis. This is intended for general investment opportunities for friends and friends of friends;, you may forward to anyone you’d like.

My goal with this is to help you have an investment plan and invest knowledgeably and patiently. This guidance is built on a premise of investing in companies, not just stocks. Therefore, patience is key.

“Nobody buys a farm based on whether they think it’s going to rain next year.” — Warren Buffet

Good investment is a long game with appropriate considerations for risks and objectives. Business cycles move through expansionary and contractionary periods that should provide you with varying levels of opportunity. This won’t be a get-rich-quick scheme.

With these monthly newsletters and consultations, what I hope to offer you is titbits of current investment opportunities, and, equally, the risks.

FINDING THE MARKET BOTTOM

Heading into midyear, both stock and bonds are down about 20% and 10%, respectively, with only a few safe harbors in commodities and, to a small extent, high-dividend stocks. Downturns such as these should, in effect, provide you with more options, but questions remains about how long the slide will continue and whether this is the time to buy (or sell). History may be your guide to evaluate the severity of the current market.

Indicators	Current	Extreme
VIX	28	80 (Oct 2008)
Put:call options ratio	0.69	1.28 (Mar 2020)
% of stocks above 200 day moving avg.	19%	1% & 5% (2008 Oct & Mar 2020)
Yield spread (Spread wrt t-bonds)	Investment grade: 2.31 Junk ( rated < BB): 5.87	Investment grade: 4.31 Junk ( rated < BB): 10.97 (Mar 2020)

Source: CBOE, barchart, FRED

Although history gives you a benchmark, your future investment opportunities depend on the economic environment of the future. It is imperative to see what is going to happen to the economy, which is notoriously hard to predict, especially when unpredictable macro factors such as COVID and war continue to disrupt the market. Your best bet, again, is to turn to history to give you cues, not in an absolute sense, but for relatable trends.

As you see in the chart below, until the 1970s, there was a belief that there was an inverse relation between inflation and unemployment. The 1970s stagflation showed that prices can be influenced by various external factors, similar to the supply factors issues we are facing today. A significant difference may be that current unemployment is low, with some sectors still facing more acute labor shortage than others.

The inflation we face currently is on the supply-side, not particularly the demand side one, with shortages of parts and labor, as well as the war-triggered food and fuel supply issues. Monetary policies traditionally address demand, tempering it by raising interest rates. Macro factors like war and COVID that disrupt energy exports, food supply, and labor shortages are hard to manage by Fed tools.

OPPORTUNITIES

Attention is now shifting from inflation to economic recession from rising interest rates. Although slower growth may revive the bond markets, stocks may continue to face uncertain economic headwinds and volatility. For comparison, the stagflation in the 1970s triggered by high fuel prices, which also caused a stock market decline of about 50%, did not recover until the 1980s. Even though we are experiencing inflationary pressures and rising interest rates, the current low unemployment and robustness of the economy are starkly different from the 1970s.

In a broad sense, there could be three different economic scenarios and investment options:

1. If inflation persists, alternatives will likely lead the way, followed by cash and certain stocks, with intermediate bonds being somewhat weaker and long bonds worse yet.

2. If inflation subsides and employment remains healthy, stocks and bonds should rebound, with alternatives and cash lagging.

3. If inflation subsides and a recession lingers, bonds will be the safest refuge, with cash close behind. Further back will be alternatives, and then stocks.

Given the supply-side nature of the inflation and very strong labor market, #1 in the short term and continuing to #2 is more likely. Let’s see how the war and disruptions related to COVID resolves.

Wishing you a wonderful summer and a happy 4th of July!

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