05 Jul Is This a Stock Market Bottom? – 2022 Q3 Commentary

One might describe the year-to-date stock market performance, at the time of writing, as lackluster. The S&P 500 index has declined 20.5% and Value Line 1700 has declined 22.7%. We have previously discussed some of the reasons for this downturn in our newsletters. So, we would like to use this space to discuss the question, “Is this a stock market bottom?”

D&K has received some form of this question from a number of clients over the last couple of months. We really appreciate this question because it means asking oneself whether “discounts” exist out there in the stock market today. Furthermore, some clients have asked whether it makes sense to invest additional money into equities. We like bargain hunting and as we discussed several times in the past, we believe volatility breeds opportunity.

D&K has two responses to the aforementioned question, which might surprise you. First, we feel more comfortable investing today than we did in the fall of 2021. Back in October we felt that the S&P 500 appeared highly valued and D&K adjusted the portfolio to reflect that view. However, as we discussed in last quarter’s newsletter, broad based valuations have declined significantly, and several sectors of the market have experienced share price crashes.

Graph 1, illustrates that only the S&P 500, which is market size weighted, has a higher Price-to-Earnings (P/E) multiple valuation than its 20 year average today. The S&P 500 Equal Weight P/E fell 9.5% below its 20-year average. The S&P Midcap index fell 21.9% below its 20-year P/E average. Similarly, the S&P Smallcap index fell 28.1% below its 20-year P/E average. Based solely on P/E valuations, today indeed looks like an interesting time to invest – something not covered by financial media.

Valuations may look interesting but those alone do not answer the question of whether we have reached a market bottom. There are still a lot of potential concerns that could have a negative effect on stock valuations. However, the second response that may surprise you is that we know something definitively. You know to question the investment manager who claims to know something with certainty. However, we know that a percentage of the potential concerns have been priced into the market by the aforementioned stock price declines. Unfortunately, we do not know what percentage of those concerns have been priced in.

Our clients who needed cash over the last six months, whether for normal expenses or planned purchases, met those outflows as a result of planning with us. If you have planned cash outflows in the next zero to 24 months, it makes sense to sit down with us and plan around those. You do not want to withdraw money from equities in a declining market.

If you have an investment time horizon of greater than 24 months and it makes sense to you that the market has priced in some but maybe not all of the negative economic, geopolitical, monetary, and fiscal concerns, then we think it makes sense to be invested today. We see several bargains in today’s market, even if companies’ earnings do come down some in the near-term. So from our point of view, given everything above, we may not know the exact answer to the original question, but we continue to execute our investment strategy of looking for valuable companies that will protect and grow your wealth.

Furthermore, Graph 2, demonstrates the importance of remaining invested throughout periods of market volatility (assuming that makes sense with your investment time horizon). The graph shows that from 1980 to 2021, a period of 41 years, if you missed the five best S&P 500 performance days, you would have 38% less money than someone who remained invested throughout that time. Missing the 10 best S&P 500 performance days would put you at a 55% disadvantage to someone who remained invested the whole time. This has two major applications to today. First, if one tries to time the market, one or more of the aforementioned “best” days noted above in Graph 2 could occur while that person is sitting on the sidelines. Second, it means that as investors we do not necessarily have to answer the initial question with certainty. We would not want to miss the days that Graph 2 discusses by trying to pinpoint the market bottom exactly. Hopefully, that provides a feeling of relief.

Thank you for the trust you place in us. We understand that volatility in the market provides uncertainty. If you need to discuss cash flow planning, please let us know. We can make a plan to insulate you from the frustrations of a down stock market. In the meantime, we move forward.