The market has been surprisingly good this year with the S&P 500 up 16% YTD. But the rally has sputtered over the last six weeks. Will the rest of the year be like the first seven months or the last six weeks?
Anything is possible and the market has a habit of confounding the greatest number of people in the near term. Both a bull and bear case can be made for the rest of this year and beyond.
There is some good news out there. Inflation has fallen dramatically over the last year. The Fed is at least almost done hiking rates. The consumer is still strong. And there is no sign of a possible recession. It looks like we are getting through this rate-hiking cycle and graduating to the next bull market and recovery without suffering the usual recession first.
Then there’s artificial intelligence. The new technology is creating huge demand and will generate a huge growth catalyst for years to come in the market’s largest sector. Technology has driven the market higher for the past decade plus and the sector is armed with the means to continue to do so.
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But the business cycle is confusing this time. It’s hard to tell if we are at the beginning of a new recovery and bull market or near the end of the last one. Maybe the economic slowdown or recession that investors are dismissing is just a little further down the road.
The consumer has remained strong despite higher prices and consumption accounts for about 70% of GDP. But that may just be because of pandemic juice that won’t last. Savings rates are falling back to pre-pandemic levels and credit delinquency rates have been rising for two years. Interest rates have raised the cost of borrowing and mortgage rates are now over 7%.
Interest rates across the board are near the highest levels in 15 years. Historically, it takes a while for higher rates to filter through the economy and start to bite. And businesses and consumers will have to grapple with much higher borrowing costs that may not be going back to the old levels. The reckoning may come soon.
Historically, it has taken more than a year and a half of rate hikes to fix inflation. Rates may still head higher or at least stay high for a lot longer than in past cycles. There could be trouble when it sinks in that high rates are here to stay, and this bull market won’t be aided by dirt-cheap rates and Fed stimulus.
The U.S. economy is almost always more resilient than pundits think. The stock market is resilient. But we may see that resiliency put to a test in the quarters ahead.
It can be impossible to predict the near-term direction of the market. Wall Street firms with armies of Ivy League superstars at computers all day get it wrong. Even if you are right about prevailing trends, a headline can come out of nowhere and change all the math. That’s why market timing has consistently proven to be a poor investment strategy.
The only market timing strategy that has consistently proven to be successful over time is to buy good stocks dirt cheap in a bear market. The market trends higher over time and stocks of good companies don’t sell at dirt-cheap prices for long. But we are in a bull market now.
While it may be a bull market for the indexes, certain stocks and sectors are still wallowing near the bear market lows of last October. The worst-performing sectors in the S&P 500 YTD are Utilities, Healthcare and Consumer Staples. These are companies that have resilient earnings in any economy and the market hates them so far this year.
Several of the very best companies in these sectors are selling near the 52-week lows and in some cases multi-year lows. And this fire sale is taking place ahead of a likely slowing economy and possible recession, a period of historical market outperformance.
Of course, there may not be a recession any time soon. The bull market may continue. But these stocks are highly unlikely to stay at current levels even in a hot market. Good stocks and sectors don’t stay down for long. Few were touting technology stocks at the beginning of this year. The sector was the worst-performing in last year’s bear market. But that sector is up nearly 40% YTD.
Few investors were interested in energy stocks two years ago. But the Energy Select Sector SPDR Fund (XLE) has returned 112% over the last two years compared to a 5.35% return for the S&P 500 over the same period.
Some currently cheap stocks in beleaguered defensive sectors like alternative energy utility NextEra Energy (NEE) and health care insurer UnitedHealth Group Inc. (UNH) have long histories of significantly and consistently outperforming the S&P in all kinds of environments.
Forget about what inflation or the Fed will do, or the severity of the economic landing or possible recession. Look to buy best-in-class stocks near the lowest valuations in many years. The rally may run out of gas in the market indexes in the quarters ahead. But it’s still last October for certain stocks.
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