Six Things That Might Go Right

Validea

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VP & partner at Validea Capital Management

During bear markets, it’s easy to talk about all the things going wrong in the market, economy and the world. And in today’s current market environment, there is no shortage of things to worry about. From high inflation, increasing interest rates and borrowing costs, geopolitical risk and tensions, disrupted supply chains, troublesome debt-to-GDP ratios and recent market excesses with things like SPACs and Meme stocks – there are plenty of reasons for investors to be concerned. Investor surveys like the AAII Investor Sentiment survey show very high levels of bearishness and low optimism about stock investing.

The losses we’ve seen so far so year in the market reflect most of the problems outlined above and stocks could certainly decline further – and even overshoot to the downside as investor fears continue, but this article takes the other side.

In this article, I’m not asking what might go wrong, but rather what might go right and what could turn things around for stocks over time.

So, what could go right?

[1] Inflation Eases / Rates Stabilize –the Federal Reserve is now aggressively raising interest rates to combat inflation. If a combination of higher prices along with more expensive borrowing costs are coupled with supply chain issues working themselves out, then it’s plausible inflation may moderate. If that happens, and the Federal becomes less aggressive, the market should take that as a positive.

[2] Growth Accelerates – while it’s hard to see growth picking up given the economic backdrop, you have to remember consumers are in relatively decent shape and still have plenty of money in their bank accounts to spend. And remember, it’s about expectations. So, if the market is expecting below trend growth and growth comes in better than that, it could be taken as a positive.

[3] Corporate Profits Hold Up Ok – higher input and production costs are hitting some companies, like we saw with Target and Wal-Mart, and some companies are lowering their earnings guidance. But in the event that corporate profits, especially among the largest companies in the market, hold up, it could be a positive for investors. Remember, companies have learned to produce with less resources after adjustments due to COVID so staying efficient and flexible is part of the modus operandi now.

[4] Russia / Ukraine War Ends – a resolution in Ukraine would at the minimum probably result in a relief rally. Longer term, it would help ease some of the supply chain issues that have resulted in higher energy and food prices. It seems like this war will have many lasting ramifications, as all wars do, but history would tell you markets are usually up 1-2 years after conflicts occur.

[5] Better Valuations, Better Future Returns – stock valuations are more attractive today vs. where they were at the beginning of the year. As valuations improve, so does the outlook for expected returns. According to FactSet, the S&P 500 trades at a forward P/E of 15.8, which is below its five- and ten-year averages. The implied earnings yield (i.e. the inverse of the P/E) is 6.3%, so that is still well above the rate you’ll get on a 10-year Treasury bond.

[7] Investors Learn & Become Better Long-Term Investors – there was an entire generation of investors who came into the market in 2020 and 2021. Those investors only saw stocks go up. But then we came into 2022 and many stocks– especially expensive growth stocks – have been hammered with former highflyers down 70% to 80%. This is a tough lesson, and I would never wish that investors lose money like that. But there is a silver lining in that these same investors are likely to be more careful, more diversified and also more realistic about investing in the markets now and in the future. Long-term, I think this will be good. Making mistakes like this now, early in one’s investing career, is sometimes the best thing for becoming a better long-term investor.

I have talked about a lot of positives here, but there is also a chance that none of these things happen and the market still moves higher. You’re probably asking, “how is that possible”? It’s possible because of expectations – if investors are assuming the worst, then anything less than the worst is actually a positive. I can’t predict where the market will go from here, and neither can anyone else. But we can all sometimes forget the positives in periods of high negativity. In the end, it’s not always about just asking what could go wrong – you also need to ask what could go right.

Originally Posted June 22, 2022 – Six Things That Might Go Right

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