Yesterday stocks sank to new lows for this bear market, as recession fears are raging. Recessions are as much about psychology as they are about economics, because we can talk ourselves into one if we create enough anxiety and trepidation. Market pundits are doing their best to accomplish this right now by conflating the carnage that is going on in financial markets with activity in the real economy. While economic activity is clearly slowing from the unsustainable stimulus-induced pace that followed the economic reopening, it is not contracting the way risk assets prices have so far this year. The market is not the economy.
I was listening to Mike Novogratz tell Bloomberg news that the economy is going to “collapse” and that “we are headed for a really fast recession, and you can see that in lots of ways.” These comments didn’t surprise me coming from the CEO and founder of Galaxy Investment Partners whose investment firm invests in cryptocurrencies like Bitcoin. His business has been through a depression. Misery wants company, but it also wants an excuse.
This was a $3 trillion dollar industry last year that is now worth less than $1 trillion today. The easiest way to explain away this disaster is to blame it on the economy and the Fed, despite the fact that the entire premise for digital currencies has been undermined. It was pitched from the start as a “store of value,” but it earns nothing, and it yields nothing. We were told it was an inflation hedge, but that hasn’t worked out either. It may be a form of currency, but who wants to rely on it when it can fluctuate as much as 10% a day in either direction, then lose half its value in months. The bottom line is that this sector is shedding jobs, losing capital, and shrinking under the weight of the normalization of monetary policy. That said, its collapse has nothing to do with the real economy except for those directly involved in it professionally or from an investment standpoint.
I am sure you would hear some dire outlooks for the economy if you asked executives from companies that had some of the hottest momentum stocks in the market over the past two years. Most of these names are technology related and trade on the Nasdaq Composite, and a handful of the most popular are held in Cathie Wood’s ARK Innovation ETF (ARKK). These were the best performers during the brief bull-market run from 2020 to 2022, but the profits have been wiped out. If you look at the economy through the prism of this collection of companies, you get a very distorted view.
Recessions are healthy and necessary events that rid the economy of the excesses built up from the expansion that preceded it. I don’t see a lot of excesses in the real economy today other than the surplus of job openings and savings. We have an excess of prices, but that is mostly due to a lack of capacity and supply.
Bear markets rid the financial system of excesses built up during a bull market in the same way, and we had plenty of those at the beginning of the year, due to a monetary policy that was too loose for too long. As can be seen from the collapse in crypto and the most expensive stocks and sectors in the market, we have largely expunged those excesses. I think we are closer to the end of this process than the beginning because investors are finally selling the good, the bad, and everything in between. Over the past few days they are selling everything, as evidenced by the fact that only 12 stocks out of the 500 that comprise the S&P 500 index rose in price yesterday.
The markets are now pricing in a recession for the U.S. economy this year, but it isn’t in the numbers as of yet. We are not seeing a slew of corporate earnings warnings either, and the end of the second quarter is less than two weeks away. Regardless, investors are so concerned about recession that they are selling the stocks of the highest quality companies at very inexpensive valuations. That makes no sense.
As an example of how indiscriminate the selling has become, there are 167 companies in the Russell 3000 that are now trading with market capitalizations below the value of the cash held on the balance sheet of these businesses. That eclipses the prior record of 165 set in February 2009 during the peak of the global financial crisis.
Even sectors that are benefiting from the rise in long-term interest rates are falling to pre-pandemic levels. The financial sector is a case in point, as rising rates greatly improve net interest margins.
Therefore, when I compare the 3.2% I can earn owning a 10-year Treasury compared to the 3.5% I can earn from the dividend paid by a company like JPMorgan (JPM), the decision is a simple one. Recession or not, I am highly confident that I will realize a greater total return over the coming 2-3 years with JPMorgan than I will with the 10-year Treasury.
The Technical Picture
Two charts give us some perspective on how deeply oversold the market is today. The first is the percentage of stocks on the Nasdaq Composite that are trading above their 200-day moving averages. Outside of the Great Recession, it has fallen to levels that coincided with bottoms over the past 20 years.
Another extreme can be seen in the percentage of stocks in the S&P 500 that are trading above their 50-day moving averages, which is now down to 2% and also consistent with previous bottoms.
These indicators don’t mean that the major market averages will not fall lower, but they do suggest that we are much closer to a bottom than the beginning of something far worse.