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Benefits at the Bottom

February 01, 2023

There are many benefits of being at the bottom of a market cycle vs. at the top. At the top, when economic and stock market conditions are so favorable that it starts to get scary. One cannot stop wondering when these good times end. I remember like it was yesterday, the heydays of 1996 through March 2000. I was part of a mid-sized portfolio management company in San Jose, and almost daily, another company would have its initial public offering (IPO) and frequently end its first day of trading up 10% to 100%. AOL was one stock that was like a gift that kept giving. The company would split the stock 2 for 1 (get two shares for one share owned), and within six months, the stock would rally back to its pre-split share price for a 100% return. The stock did these “round trips” three times when I owned it. Amazingly, AOL was just one of many such experiences during these years, and of course, we all feared the day all this fun would end.

The day of reckoning started on March 10, 2000. The tech-heavy NASDAQ index plummeted 36% by May 2000 and eventually bottomed in March 2003, dropping 73.5% during the previous three years. Many of the former IPO darlings had filed bankruptcy, and many newbie stock traders lost all or more their original capital and returned to their day jobs (Wall Street Journal featured articles in the 1990s of people quitting their jobs because their stock trading was so profitable).

NASDAQ drug down almost all other stocks and major indices, entering bear market status (down greater than 20%). At the top, you only have fears.

But at the bottom, there is only up. Despite the surprising stock market rally in 2020 and 2021, it did not represent the economy. This was one of the strangest disconnects in recent memory as the stock market rallied to new all-time highs and the economy sunk into a recession. While the S&P 500 was rallying up 42%+ these years, the US and world economies were imploding as businesses were mandated to shut down, supply chains were frozen, and people were isolated in their homes. Russia added to these challenges with its attack on Ukraine, and China extended its nonsensical zero-tolerance Covid policies into late 2022, then absurdly suddenly reversed its policy.

Needless to say, investors and consumers were left in confusion as to what to believe. If the stock market was not already posed for some correction, then the new rate hike policy of the Federal Reserve would make sure stocks would correct. The rate hikes reversed a 40-year bond rally with its worst year of performance since the Great Recession in 2008. All major stock indices dropped in 2022, with NASDAQ leading the way to the bottom, declining 32% 2022. We all lived it last year and knew this all too well.

However, as mentioned, at the bottom, there is less to fear and more to look forward to. University of Michigan, Consumer Sentiment Index declined from 2020 through 2021 even as the stock market rallied. However, the consumer sentiment index plunged to its lowest level since 1978 as the Federal Reserve was on track to increase its discount rate from 0.25% to 4.5% pushing mortgage rates up from 3% to 8%.

This may explain why the holiday retail sales were below most analyst expectations as consumers with a less favorable outlook on their finances and the economy held back their gift spending even with declining gasoline prices.

But as mentioned, at the bottom, there is only one up. As illustrated below, the consumer sentiment index has recovered a bit from its June low but still has a long way to go to return to the optimistic days of yore. From 2016 to 2019, the index was regularly above 90, that by June had dropped by 40%, and even with small improvements January level is still down by 30% with a reading of 64.9.

The key benefit of investing at the bottom is there is so much more potential for gains than investing at the top. You may eke out another 10% in gains at the top, but opportunities at the bottom can be fantastic. 2023 is already showing signs of such a rally, with outliers popping year to date like Tesla (TSLA + 40.7%), Amazon (AMZN + 33.6%), and Nvidia (NVDA +22.7%).

All three stocks still have a long ways to go to return to former highs in late 2021, but the recent rally is encouraging.

What Does This Mean to Me?
We would propose that the US economy and stock market reach the bottom in the near term. My experience is market conditions are on the recovery when stocks start to pop like those mentioned earlier. The beginning of a new uptrend starts as institutional investors change their investment philosophy from defensive to opportunistic. Admittedly, investors are fickle and can change just as fast back to the doom and gloom, but this tends to be less frequent after market corrections when stocks are already down 50% to 78% as AMZN, NVDA, and TSLA were respectively from their previous all-time highs.

There are valid reasons for investor optimism as issues taxing the economy in 2020 through 2022 are being resolved as supply distribution channels are near previous high volume, lower energy and fuel prices, and slowing inflation. Meanwhile, unemployment remains at 40-year lows as it appears those being laid off are quickly assimilating into new jobs. More households in history have 30-year fixed mortgages below 4%, and wage increases in 2022 will help keep pace with what may be a short-term jump in prices.

The S&P 500 has moved into a positive trend being above its 20-Day Moving Average (DMA), 50 DMA, and 200 DMA. More confirmation of a bullish trend would be when the index rallies above previous highs reached on December 1, 2022 (4080) and the next previous high on August 15 (4297).

I read this week that the bears (negative prognosticators) are calling this recent uptrend “climbing the wall of worry .”My experience with bears is this is about as good as they get in feeling good about the market.

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