As we approach the dog days of summer, this timeless question from family road trip seems particularly appropriate. In today’s financial markets, we’re referring to the decline in virtually every asset class and asking, “are we at or near the bottom yet?”
Before we address the question, it’s helpful to understand how we got here in the first place. Here’s the Cliff Notes version:
Coming out of the Financial Crisis in 2009, the Federal Reserve (“The Fed”) engineered a low interest rate environment by flooding the markets with cheap money – keeping them there for a long time. Then Covid happened, and they repeated the process. What happens when there’s plenty of cheap money available? Assets of all types get bought up. Real estate, stocks, bonds, cryptocurrency, etc. When you have too much money chasing too few assets, prices sometimes tend to get ahead of themselves. And when uncertainty about the future shows up, and all these assets are priced to perfection, markets tend to correct. That’s where we are today.
The $64 question is – are we at the bottom yet? It’s an impossible question to answer, of course. We can tell you that stocks represented by the S&P 500* are currently back to their long-run average price/earnings ratio of 15.7%. This would seem to indicate that markets are now fairly valued on a historical basis. But in past bear markets, stocks tend to overshoot on the low side before recovering. In short, we think the worst is behind us, but markets may have another leg down before they find a bottom and start their recovery. Or we may be there already. The old Wall Street saying goes, “nobody rings a bell at the bottom.”
There is some good news in all this. Unlike past bear markets, corporate earnings and the consumer are in remarkably good financial shape. Corporate profits are expected to grow for the rest of the year – albeit slower than initially expected. (During the Financial Crisis of 2009, corporate earnings shrunk by more than 50%.) Further, corporate balance sheets are flush with cash, allowing them to weather a downturn in the economy and invest for future growth. As for the consumer, a few facts:
- Household debt as a percentage of disposable income is at its lowest level in decades. (Translation: Consumers aren’t overleveraged like in past downturns.)
- Consumer savings (deposits in money markets, savings accounts, etc.) are at the highest levels on record. (Translation: Consumers have plenty of dry powder)
In short, this downturn isn’t driven by an overleveraged consumer or corporate weakness; it’s driven by a Fed policy that pumped trillions of dollars of cheap money into the economy. And now, the Fed is trying to reverse course by raising interest rates to combat inflation and pulling some of that excess liquidity back out. The markets are simply trying to determine the fair value of assets based on the Fed’s path. As we’ve said, the markets are very good at pricing assets in the long run, but it can be very messy in the short run. That’s where we find ourselves today.
Our counsel to readers remains the same: All corrections end in a recovery. Given the financial health of corporate America and the consumer, this one may be more robust than past recoveries. Stay the course and call us if you have questions or want to chat.