There's More to Come
Markets are collapsing. The headlines are piercing. Investors are crumbling.
In fact, investors have been selling down stocks at a rate not seen since the GFC, and depending on which metrics you use, since 1975. In the chart below I have plotted the valuation change, year on year, and you can see the absolute cliff that is valuation compression since this time last year. As quickly as we saw valuations sky rocket last year (I'm not going to go into the reasons here), valuations have fallen even quicker - 2021 was insane, and we're now paying for it.
Why is that you ask? S&P 500 company profits are in good shape. In fact, they're at record levels as seen in the below chart. Never seen such profits in history.
What goes up, must come down. Of course you say, I knew that. Right. Then why are stock valuations coming down? Simple. Investors are anticipating the future. Whether that be a recession, a fall in earnings, or more difficult times ahead. In fact, PMI, or Purchasing Managers' Index, is already declining. It's a measure of economic trends in manufacturing. It measures things like orders, inventory, production, supply, deliveries, and employment. It's a good indicator of where the economy is at.
What I've done here is plotted PMI and overlayed this with corporate profits. As you can see there is a pretty neat correlation there. The thing that stands out to me is the recent decline in PMI. You can also see the the red line appears to have peaked and turned.
Are earnings about to decline? Yeah sure, probably - that's certainly what all the indicators are pointing to. In fact, there is about a 6 month lag between PMI and corporate profits.
I mentioned earlier that investors are crumbling. Well, that's what we're being told anyway. I wrote a note not that long ago, Consumer and Investor Contradictions, where I looked at what consumers were saying versus what they were actually doing. Here's an update to that note. Investors are feeling super bearish right now, in fact, it's the lowest level of bullishness we have seen since the early 90s' - crazy!
In this chart I plotted consumer sentiment - you can see we haven't seen such levels since before 1990, and I've overlaid it with investors' positioning or allocation to stocks. Historically investor's have acted with their feet and reduced their allocation to stocks at the same time as their sentiment has dropped. Right now, sentiment is low, yet investors are continuing to hold a good chunk of stocks in their portfolios (about 67%). Listening to what people have to say about what they think or about how they feel is meaningless until you have visibility into what they are actually doing.
What do investors' make of all of this? Do you sell your stock holdings now in light of this information? If you are going to do anything like that, you should have done so a few months back, not now. Markets have priced in a lot of damage already. Do you reallocate to more defensive assets? I then ask, why and how did you come up with your Risky/Defensive split in the first place? Going back to your why as it relates to asset allocation is super important. Do you start piling into stocks and bonds? Well, now that's an interesting question, and one to ponder. Let me leave you with this fact: Since WWII there have been 14 instances where the stock market has fallen -20% or more. One year following the initial -20% decline, historically, the S&P 500 has been up 78.6% of the time with an average increase of +17.70%. There have only been 3 instances when the market wasn't higher following a -20% threshold; 1973/74 (down a further -26.92%), 2000/2001 (down a further -1.24%), and 2007/2008 (down a further -29.08%). Having said this, there are no prizes for guessing what happened after that.
There's a lot of money to be made out there. I'm not calling the bottom. I'm just saying there is a reason why they say “the time to buy is when there's blood in the streets."
Market are unpredictable in the short-term, and far more predictable over the long-term. Work out which game you want to play, put on a jumper and get out there.