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Pacific Capital Associates

Financial Advisors in San Diego, CA

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Is the bear market behind us?

September 13, 2023 By Rich Toscano

September 12, 2023:

Last year was a famously bad one for both stocks and bonds. There hasn’t been much respite for bonds, as they are barely positive in 2023 despite having one of the worst calendar years in history in 2022. But it’s a completely different story for stocks, which have recovered a good amount of last year’s losses. (1)

So is the stock bear market over?

We don’t know the answer to this question, and we’re convinced nobody else knows either. And it doesn’t matter much for value-oriented investors in any case. But we thought it might be interesting to quickly outline the case for and against further near-term pain in the stock market. After that we’ll talk about why we don’t think the question is super relevant, and then we’ll review our multi-year investment outlook (which is very positive!).

Could a soft landing help avoid a dot-com style slog?

The bull case can basically be described in two words: Soft Landing.

This phrase describes the idea that inflation will decline to its target level without a recession taking place. A soft landing would allow for interest rates to decline in a growing economy, which would be generally quite positive for financial assets. The evidence for a soft landing has been building this year, as inflation has fallen while the job market has remained very strong. Stock investors appear to have become quite confident that a soft landing is in the cards, and if they are right, then the bear market may very well be in the rearview mirror.

The main counter is that soft landings are a pretty uncommon conclusion to Federal Reserve tightening cycles like the one we’re in. More often than not, rate raising cycles have been closely followed by recessions. Soft landings have happened, but they’ve been less common, and have tended to happen after gentler rate increases than we’ve experienced this cycle.

Fed funds rate and inflation

Seventy years of the Fed Funds rate, with recession periods in gray.

There’s another cause for concern, in our view, which is that US growth stock valuations are back in nosebleed territory. We had written for a while about the craziness in the growth stock sector, and while they were indeed shellacked last year, this year’s rebound has brought them back to bubble-like levels of expensiveness.

Growth vs. value relative expensiveness

Relative valuations between the value and growth halves of the US stock market. When the line is lower, value stocks are cheaper and growth stocks are more expensive. 

Was that it for the growth stock reckoning? It’s possible, but given the behavioral and valuation excesses that were reached in 2021, we feel that would be a fairly lucky outcome. This year’s rebound is encouraging but doesn’t get us entirely out of the woods — for example, the multi-year tech stock bear market that followed the dot-com bubble included several blistering rallies, including two of 50% or more. (2)

There are some plausible threats to the soft landing outcome, in our view. But when it comes to short-term outcomes, you just never know. A year ago, investors were pretty convinced that a recession was imminent. That seemed like a reasonable view at the time, but it turned out to be wrong. Now they appear almost as confident that there will be no recession at all. And this is also not unreasonable, given the recent improvement in economic data. But it may turn out to be just as wrong as last year’s view.

A little further out — looking good

Hopefully it’s clear that we really don’t think it’s possible to reliably know what markets will do in the short term. (Why write about it? We find it interesting to think about, and we hope our readers do too!)

This is why we don’t base our investing strategy on short-term predictions. Instead, we aim to allocate to a broad mix of investments that have good expected returns in the years ahead, regardless of what may happen immediately down the road.

Viewed through this lens, the current situation looks very promising. Even after this year’s rally, a global, value-tilted stock strategy has a higher-than-historical-average expected return. (Put another way, it’s cheap). And thanks to the dramatic rise in interest rates, the opportunities outside of stocks are the best we’ve seen for a very long time.

There are pockets of the stock market that we still view as perilously expensive , but a lot of great opportunities outside of that. Our multi-year view is accordingly very positive for global value-focused investors.

 


1 – Source: Koyfin, using AGG and VT

2 – Source: Koyfin, using the NASDAQ 100

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