Market players constantly look back to stock market history to find a parallel that would help decipher today's path forward.
The current market conjures the painful mid-1970s dealing with stagflation -- spiking inflation coupled with slowing economic growth.
In the early 1980s, Fed Chair Paul Volker precipitated a sharp recession by aggressively raising rates to battle inflation.
The 2000 Nasdaq Bubble, akin to the pandemic bubble, preceded a deep recession and three straight down years for the S&P 500 along with an 80% decline in the Nasdaq.
A growth scare and hawkish Fed caused a 20% stock market decline in 2018 that quickly reversed after the Fed pivoted more dovish.
Inflationary macro climates or the aftermath of asset bubbles often lead to a recession, so given that the market is currently dealing with both issues, it's no surprise that many pundits predict a coming recession. Arguably, capital has been misallocated to cryptocurrencies, and to tech stocks that were valued at excessive price/sales multiples, reminiscent of the Nasdaq Bubble. Under a tightening monetary regime, the destiny of these assets is still to trade lower.
When the Nasdaq finally bottomed in 2002, investors wanted little to do with tech stocks. The bottom was marked by an attitude of investor apathy, not opportunity. Expect this to come down the road, especially in crypto.
Mike Wilson, Morgan Stanley's equity strategist, who has been directionally correct, issued a report on Monday with a plausible scenario. He foresees another leg lower in stocks, starting with the July second-quarter earnings reporting season, with weakness continuing into the third quarter, triggered by downward earnings revisions.
Wilson sees the market bottoming in the 3400-3500 range for the S&P. 500 At the beginning of this year, he correctly targeted 3800 as a potential bottom.
For now, the relative market stability is the calm before the storm. The market is far more forgiving of recent lowered earnings guidance, with Target (TGT) and Microsoft (MSFT) both holding up after reduced expectations. But, if Wilson is correct, the bearish market action seen earlier this year has been a preview of what's to come -- a resurgence of fear and loathing brought about by weak earnings.
He notes that much of the reduction in equity valuations came from multiple compression, without much impact from earnings. Since the process of earnings reductions takes time, Wilson looks out months ahead for a clear market reaction to what he sees as a problematic earnings outlook.
Wilson's scenario is plausible in light of the Fed's tightening monetary policy, including balance sheet runoff of $47.5 billion per month through August and $95 billion monthly thereafter. A premium on cash and a dash for capital preservation could lead to the final capitulation in this cycle.
Importantly, the last place to invest is in assets where valuation is difficult to ascertain, such as private startups, cryptocurrencies, and unprofitable tech.
Of course, the past is not always prologue, yet history offers lessons that can be a good guide for market forecasts. Prudent preparation for a potentially tough market ahead seems warranted.
Aggressive Fed tightening, the war in Ukraine sparking food and energy inflation and shortages, corporate margin pressure, a strong dollar, and continued deflation in asset bubbles can all conspire to make for a bearish resurgence in the second-half.
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