Barring a miracle, 2022 will be a year to forget for market participants.
Ironically in the context of that characterization, the scope, and particularly the breadth, of the cross-asset malaise means this year will never be forgotten.
If posed as a hypothetical ahead of time, the uniformity of this year’s losses (figure below) would be difficult to accept as reality. Let me be as clear on that point as possible: I don’t care what anyone on finance-focused social media says about any “bad feelings” they harbored on December 31, 2021, nobody could’ve predicted simultaneous 15%+ drawdowns for stocks, Treasurys, high-grade credit, and high yield, alongside double-digit losses for gold, existential routs for cryptocurrencies and devastating drawdowns for many of America’s most important tech champions. Such a conjuncture is unfathomable, especially when you place the drawdown in bonds and IG credit in a historical context. (There is no historical context. You have to use reconstructed time series to find comparable drawdowns).
You can, I imagine, dredge up doomsday predictions about stocks and other assets from the usual suspects, but how many of them would’ve predicted gold and Bitcoin would also be mired in deep slumps despite 40-year high inflation across the developed world? That’s easy to “predict” in hindsight. Here, I’ll show you: Of course gold and Bitcoin are sharply lower — money isn’t free anymore now that central banks were forced out of a decadelong experiment in extreme monetary largesse, and Fed hikes pushed US real rates inexorably higher, taking the dollar along for the ride. Like all things, every aspect of 2022 was predictable once you lived through it.
I should note, though, that as bad as 2022 is for investors, it doesn’t compare to 2008 in terms of the overriding sense of existential dread — or at least not from a pure markets perspective (i.e., forgetting that the world is closer to a nuclear conflict than it’s been since “Cold War” was a proper noun). This time 14 years ago, there were still very serious questions about whether the US financial system might cease to exist as we knew it. That’s difficult to wrap one’s mind around in the era of “Whatever it takes” central bank backstops, but it was touch and go there for a while.
Anyway, if you’re curious to know how bad market sentiment is with less than two months to go in what may well go down as the single worst year for cross-asset returns in (modern) recorded history, note that BofA’s pseudo-famous Bull & Bear Indicator has spent seven weeks parked at 0, and it’s been there on several other occasions this year.
The figure on the right (above) shows two decades of history for the indicator (half of which is backtested). The current stretch of extreme bearish readings is the longest since the flatline that persisted from July of 2008 to April of 2009.
Looking ahead, BofA’s Michael Hartnett continues to favor a 70s analog, and he went to great lengths to expound on that in his latest. I’m reluctant to parrot that sort of analysis. It’s not that there’s anything “wrong” it, and Hartnett does an admirable job as these things go. Also, I’m as much a fan of Hartnett’s as anyone else. The problem, from my perspective, is that it’s very difficult for analysts tasked with penning real-time, weekly commentary to check every box when it comes to drawing historical parallels. It’d be uncouth of me to suggest that any strategist needs their work fact checked, so let me put it another way in the interest of being polite: There’s not enough time in the day to fact check that sort of analysis if it needed fact checking, and as such, I’m uncomfortable with sweeping claims about bygone eras and their purported similarities with the present.
Currently, I’m reading Alan Blinder’s new volume, “A Monetary and Fiscal History of the United States, 1961–2021,” named, of course, for Milton Friedman’s tome. When you’re deep into exhaustive, comprehensive accounts such as Blinder’s, bullet point summaries of the same events aimed at establishing parallels and developing trading strategies are difficult to countenance as sufficiently thorough. The Fed was a different animal back then, for example. Attitudes about the proper role for monetary and fiscal policy were undergoing a sea change, as were economic frames of reference themselves. Tempting as it is, this just isn’t something that’s amenable to the kind of analysis that we all like to write and read every week.
Hartnett wrote, of 1974 and today, that there are “many similarities… big, fat trading ranges, co-dependency of Wall Street and the Fed, stop-go economic policies, Fed emphasis on core not headline inflation, political instability, war, oil shocks, food shocks, fiscal excess, industrial unrest and so on.” That’s all well and good (or well and bad, depending on whether you’re talking about the effort to draw a parallel or the events themselves), but every, single one of those points is it’s own unique story, with its own unique actors, and frustrating as this is, if you want to draw parallels, there are no shortcuts. I’m not suggesting Hartnett was offering one. What I am suggesting, though, is that if it’s a 70s parallel you’re looking to draw, you really need to consult comprehensive, historical accounts of that period. Even if you lived through it, Blinder’s account is very useful in that regard. There are, of course, many others.
All of that said, Hartnett’s argument for small-caps in a stagflationary environment has merit with or without the late 70s comparison he uses to make the case. Small-caps can outperform if the coming years are indeed defined by stagflation, he said, because they’re “price-takers not price-makers so penalized less by inflation,” are localized and thus benefit from fiscal stimulus as opposed to large-caps, which benefit from globalization and monetary stimulus, are less likely to have their profits siphoned by governments, and typically begin to outperform during a recession. Further, US small-caps are “more correlated with leadership in the next bull [market],” Hartnett said, suggesting that industrials, financials and resources will lead, before noting that small-caps are trading near record relative multiple discounts to large-caps in the US.
The figures (below) show cross-asset returns in 2022 (on the left) and 1973/74 (on the right).
There are obviously some similarities there, but there are glaring differences too. If anything, the 2022 chart again underscores how truly bad this year was.
Ultimately, Hartnett sees 2022’s “Big Bear” transitioning to a “Little Bear” in 2023, in part because Treasurys are unlikely to have another down year, and inflation will probably ease at least a little bit.
Nevertheless, stagflation is the most likely macro conjuncture and as such, BofA’s preferred asset allocation analog remains “the 70s” where, according to Hartnett, that means “long cash, commodities, volatility, small-caps, value, resources and EM,” while being “short stocks, bonds growth and tech.”
“long cash, commodities, volatility, small-caps, value, resources and EM” seems to obvious, but then again, sometimes the obvious answer is the right one. My guess is that tech, and specifically FAAMG, is a good place to park money right now. These companies are still highly profitable even with a strong dollar and may be able to take advantage of the current economic environment to trim headcount without as much crazy competition for talent since startups won’t be sitting on massive venture capital hauls for a while.
I agree with your Meta purchase at these levels (and purchased some myself as well) and wouldn’t be surprised to see a nice pop tomorrow with news of their pending layoffs. Now would be a fantastic opportunity to deploy some of their massive cash pile toward buybacks. FAAMG strikes me as low risk at the moment, but then again, I’d have been a lot better of historically if I had taken the George Costanza approach and done the opposite of whatever my instincts told me to do.
I don’t know whether the job cuts are bullish or bearish. My guess would be bearish in the near-term, but we’ll see in very short order. Costs were a big reason for the post-earnings rout, but the costs people are worried about are tied to the metaverse push — that’s where some critics want cost discipline. Doesn’t change my general thesis on this (which, again, is just that either he wins augmented reality or it costs so much in development that he’s ultimately forced to pivot), but the optics around job cuts announced weeks after earnings aren’t the best in the world. Ultimately, though, this is a company that hauls in a lot of money irrespective of the top-line growth rate, and profitability can ~double overnight by eliminating Reality Labs. Down 73% I felt like I kinda had to give it a look. I said the same thing to a friend in Q2 2020 about oil & gas stocks. That was one of the best investments I’ve ever made and it wasn’t based on any kind of prescient macro call about what the post-pandemic world might look like. It was just based on a kind of “Well, either the biggest energy companies on earth are going out of business or they aren’t, and my guess is they aren’t.” Same principle with Meta.
It’s also interesting to ponder the different ownership structures in the FAAMG and Tesla cohort. If you look at the big bets of the companies and founders, there are some interesting similarities and differences in how they approach innovation and their vision for the future.
Meta is still essentially under Zuckerberg’s full control, so he uses the resources of the company directly to drive his big vision. No one can really stop him due to the way ownership and voting control was structured. To your point, he could either be right and dominate a new space (after all, how many metaverses would be viable?) or he eventually walks away from either the metaverse or Meta itself to focus on whatever else catches his eye. I admit that it’s hard to imagine him deciding to walk away given he has full control and massive resources at his disposal.
Tesla is still innovative, but Elon has had to go outside of Tesla to pursue his other grand dreams of space exploration, “free” speech, and whatever else catches his eye. Correct me if I’m wrong, but Tesla could ouster Musk if he became too much of a liability. At this point, the company can stand on its own even if Musk owns a decent chunk. Could he end up like Steve Jobs and get pushed out of his own company? Would that be a good thing or would he come back as Tesla’s savior a la Steve Jobs?
With Microsoft, Bill Gates clearly went the philanthropic route instead of pursuing virtual reality or space. I don’t know that Microsoft is particularly innovative so much as they just dominate their space.
Amazon is willing to experiment in a lot of areas, but are ruthlessly efficient about it. I wouldn’t say they have the grand visions that someone like Musk has, but they’re clearly willing to continually disrupt themselves and their industries. Jeff Bezos does have his own pet space project, but not sure he’s involved in much else.
Google is a bit of an oddball in that they do take flyers on stuff that is seemingly out there. I can’t think of anything too recent where they clearly disrupted something recently even though they have had their Google Labs working on a lot of out there projects over the years. Similar to Microsoft, I think they can just rely on their bread and butter at this point and be successful for many years.
Apple is Apple and knows design and brand better than anyone else except maybe Tesla. No one really owns enough of Apple to control it in the way that founders do at Meta, Amazon, and Tesla, but Tim Cook clearly knows how to keep things operating without missing a beat.
Interesting comments regarding Meta, gentlemen. Zuck let the discussion (and talk about possible applications of the product) get away from him. I presume application of the product will be revealed in time. In the meantime, Meta is down 4x from one year ago. It’s not like it deserves such a smack-down.
What’s interesting over a long perspective is the evolution of globalization, its supposed demise, and the global reset that is playing out before our very eyes.
My heavens! Haven’t Russia and China picked a bad time to shoot themselves in the foot! Of course, Russia has been more obviously blundering (in Ukraine and in mismanaging affairs at home). But China’s posture regarding Covid, and the way their leaders incline themselves to an inward turn, including a very defensive stance regarding Taiwan, can very possibly yield self-inflicted wounds to their economy.
Russia and China could not have picked a worse time to make these turns. Globalization’s supposed demise and the restructuring it necessitates in economic relationships and trade around the world will be interesting to see. China is not yet as bellicose and belligerent as Russia. The Chinese still have a chance to capitalize by continuing to have an open and accepting posture. But that does not seem to be likely at all in the recent CCP elevation of Xi Jinping to Grand Poohbah.
For what its worth, I re-ran my valuation models for SP500, SP400 and SP600. Used uniform assumptions for each: rF 50bp higher than current, N5Y FCF CAGR -10 ppt lower than cons, terminal FCF growth 2%, 2023 revenue 5 ppt and EPS 18 ppt lower than cons, etc. I get SP500 overvalued by high single digit percentage points, SP400 undervalued by mid-teens ppt, SP600 undervalued by low-20s ppt. That is market cap weighted.
These are crude tools but directionally may be interesting.