A myriad of predictions abound for a difficult second half of 2022. The most accurate strategist this year, Mike Wilson from Morgan Stanley, has been forecasting a pullback to a minimum of 3400 to 3500 on the S&P 500. Many strategists are predicting far lower levels, closer to 3000. Even in the event of a clear recession, I plan to stay reasonably nimble near-term and become an aggressive buyer around 3500 and below.
Strategists and pundits will always call for potentially lower levels in a downtrend, so the specter of risk will be notable. Keep in mind that bottoms often look scary, and following a downtrend to lower levels usually seems the obvious choice. To quote from my novel, "The Trading Desk": "Even after the market takes something to the moon, somebody will always declare it can soar even higher; and regardless of how far something falls back to Earth, somebody will always say there's room to get buried deeper."
There's always the possibility the bottom of this bear market has already been made -- it's just not what I expect nor am positioned for.
There's no doubt that many stocks I've written about bullishly this year have succumbed to market weakness and recession fears. As high-quality companies have come lower, I'm generally more bullish about buying them at better prices. I'll likely hold and add to long positions on weakness. On the other hand, I'd avoid the lower-quality stocks even on weakness. I hope to be positioned out of this bear market in high-quality, reasonably priced stocks. I follow Warren Buffett's advice, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
The starkest investing difference between now and six months ago is the effect of much higher interest rates on corporate debt. A much higher cost of capital makes balance sheet scrutiny an imperative. Lower quality companies in need of financing will pay steep rates to refinance debt or fund working capital. During the pandemic, the Fed helped innumerable companies avoid bankruptcy with abundant, cheap capital. As money gets tighter in coming quarters, the Fed won't be a savior for low-grade borrowers allowing a more Darwinian business cycle to unfold.
One of the most prominent mistakes investors made during the pandemic was to extrapolate the trend too long. Demand was pulled forward, and now the year-over-year declines in revenues for companies that were pandemic beneficiaries are leading to tremendous investor uncertainty and depressed valuations. Many opportunities will emerge from the opposite effect of investors extrapolating declining revenue for too long and throw in the towel on companies that will once again thrive. A look back at Cisco (CSCO) after the Nasdaq Bubble in 2000 offers a good case for redemption after its over 80% drop from the peak in 2000. Cisco's revenue declined in 2002 after years of strong growth, but after basing for two years, strong sales growth resumed.
Energy was the top-performing industry in the first half. Although energy companies have the upper hand on pricing and a supply vs. demand imbalance, this is not a group I would chase. The oil industry is in control today, but I suspect that won't last. I'm more of a buyer in clean energy, mainly through solar, lithium, and copper-related companies.
The market decline in the second-quarter was so unrelenting that a reprieve can occur and be welcome at any time. Indeed, a fair amount of bad economic news is now baked into current stock prices. Even amid this bear market, the seeds of the next bull market could be forming. Overly negative positioning with resolvable conflicts, supply chain issues, and inflationary pressures could lead to a potent market upside in the second half. Still, the weakening economic momentum, aggressively tightening Fed, and global challenges must be respected. A few more growls from the bear market are probably in store.