Thursday, June 9, 2022

Recession or rally?

In this post I will breakdown why the market could have both a recession and a rally all while remaining in a challenging market for longer than expected. The S&P is currently in a 5 month bear market that started in January of this year. However, many speculative areas have been in a bear market for 12 months or longer. ARKK, XBI, spacs, and meme stocks all peaked in early 2021 and are down 60-90% from their peak. Below is a chart from Jurrien Timmer showing all bear markets and serious corrections since 1871. 

 

Lets get right into the data.

A tweet from Liz Ann Sonders shows the probability of a U.S. recession (based on the 2s10s yield curve per @Economics) has risen to the highest since February 2007

 


This tweet from Jim Bianco is dated but still relative as oil continues to rise. Not every recession is led by a 50% rise in crude but every 50% rise in crude has led a recession. 

 

Charlie Bilello takes a look at consumers balance sheets and it doesn't paint a pretty picture. Americans savings rate is the lowest since 2008 while their borrowing has seen the largest increase since 2011. 

JP Morgan CEO Jamie Dimon piles on the bearish case in his most recent comments as he is calling for the potential of storm clouds to turn into a full blown hurricane. 


Even with all the bleak data counter trend rallies are a common trait of bear markets. Below is a chart from Nautilus Cap showing all the 5% counter trend rallies during the 2000 bear market. 

 

Some positive news and maybe why this market is poised to rally.  Ryan Detrick displays all the corrections in the S&P 500 since WWII. The average correction takes 133 days to bottom. The recent 18.7% correction bottomed in 137 days. 

 

By far one of the best comparison charts is the recent tweet from Jurrien Timmer. He outlays how the current environment mirrors the patterns from the late 1940s. However there is a big issue the current market is dealing with in regards to valuation, earnings estimates, and cost of capital.


There is a lot of data to back up the recession debate. My guess is just as good or bad as they next pundit whether the market goes into a recession or not. But we do know some historical precedent that can help guide our thesis and positioning. What the data does show is the rapid rise in oil is usually a problem for the economy. We also know that recessionary bear markets are historically longer and deeper than non-recession bear markets. The average forward P/E for the last 10 years is 16.9. During a correction that ratio has gotten as low as 13 during the 2020 pandemic lows. Even after the recent contraction in the forward price/earnings valuation for the S&P (from 23x to 16x), at 17.4x, the current market is only fairly priced and not historically cheap which is associated with bear market bottoms. If the S&P traded to a reasonable 15 P/E based on forward estimates it would sit at 3600. That would equate to another 12.5% downside from here. 

 


As Jurrien put it, "perhaps sideways is the new up, and we remain stuck in a long trading range, just like the 1940's analog." Considering most new traders in the last decade are used to buying every dip to watch markets race back to new highs, it is conceivable to have an extended chop fest to confuse the masses and hit the ultimate uncle point. Part of being a good investor is being flexible and aware of multiple scenarios.


Ryan Worch is the Managing Director of Worch Capital LLC. Worch Capital LLC is the general partner of a long/short equity strategy that operates with a directional bias and while emphasizing capital preservation at all times.

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