It's a Chicken Little Market
by Alan Ebright, on Jun 14, 2022
As children, I think we all were taught the story of Chicken Little. If you’ve forgotten or never heard the tale, here’s a brief refresh. A young Chicken Little was out foraging when he was hit on the head by an acorn, but he came to the hasty conclusion that he was instead hit by part of the falling sky. He quickly spread his worry (“The sky is falling! The sky is falling!”) to all his friends on the farm, who, in turn and without thinking for themselves, spread it to all their friends. This persisted until the entire farm was convinced and worried that the sky was indeed falling.
Feeling completely and utterly vulnerable, the entire group felt it necessary to appeal their concerns to the king, so off they trekked to the castle to hopefully hear a voice of reason. Along the way, they encounter Mr. Fox, who plays on their fears, and convinces the bunch that he’s got a secret passage to the castle, the entry to which is through Mr. Fox’s den. There are various endings, and in the most grotesque version, Mr. Fox eats all of them after they willingly follow him into his den.
There is no doubt that this year has seemed like that fateful day when Chicken Little was struck on his head. There has been absolutely no place to hide. No safe harbor for this storm. Even the sectors of the market that are deemed defensive or “safer” when stocks head south have had a rough go of it. As I type this letter, here are some return statistics that I obtained with a simple on-line search:
The S&P 500 is the benchmark for the 500 largest US stocks. The MSCI EAFE is a benchmark for stocks domiciled in the geographies footnoted, and the S&P Lat Am 40 is a benchmark for stocks located in those respective geographies, also footnoted. GLD and SLV are both proxies for gold and silver bullion.
The bond market, which is so vast and contains so many different varieties, has also suffered one of their worst periods in history. Right now, Chicken Little not only has the ear of all his friends on the farm, but they’re fast on their way to have another talk with that king!
So, for the sake of my story, the “sky” will represent a combination of every investible asset class and the daily news…right now. “Mr. Fox” will represent the perceived safe haven of cash, and the “king” …. well, he’s the voice of reason that Mr. Fox does not want you to hear or meet.
Uncomfortably, we are in one of those market environments that only come around every so often. We know full well that this is never fun to watch unfold. Nothing seems to make sense right now. Are we in a recession? Is one coming? If so, when? This year, next year? Is it priced in? Opinions abound and facts seem hard, if impossible, to find.
Here are some of the different chunks of sky bumping us on the head:
- The stock market seems to be in free fall
- A recession is coming
- The housing market is weakening
- Corporate profits could start to slow
- Interest rates could keep going higher
- Inflation will continue
- Gasoline prices go higher
- The war in Ukraine escalates
- Parts of China on lockdown
Yes, all these headlines alone have a negative tone, and when combined they look like the ingredients for one huge disaster cocktail. What’s more, trying to pinpoint the start or end of a recession or the start of end of a market correction is something that economists and professional investors have tried to do for generations, yet nobody has ever been able to do it with any consistency or accuracy. There is no starting bell or ending buzzer.
There also is no garden variety recession because the causes and effects are always unique. The effects on the stock market are also different, as some recessions cause less of a stir than others. When looking back through history, what tends to happen (as a recession’s main cause) is the onset of some extremely large and negative event that comes out of seemingly nowhere and knocks trillions of dollars off global GDP. As we sit here right now, all the issues that we’re discussing are so front and center that they have most likely already been heavily discounted by the stock market. They are widely known events, kicked around daily, and the market has a way of discounting all widely known information. Could there be something stirring out in the ether that is currently undetected? Possibly, but we cannot worry about the unknown, for that would be a thesis to never invest, and that is not what we practice here at Hodges.
Investor sentiment has also tilted into very bearish territory. As twisted as that might sound, it’s actually a positive. Sentiment indicators oscillate between giddy and dour, and the market tends to pivot at those two extremes. Giddy sentiment tends to be followed by corrections, and dour sentiment tends to be followed by a bounce. If you look at the American Association of Individual Investors site, one of the keepers of such data, you’ll see that we jumped into the 50%+ bearish camp three times in the last three months; 3/26: 52.07%, 4/27: 59.3%, 5/25: 53.5%. For reference, the reading on March 26, 2020 (around the “pandemic low”) was 52.07%. The most bearish reading since they’ve been keeping records (70.2%) was recorded on March 5, 2009, about two weeks before the market bottomed out during the Great Financial Crisis. So, these periods of extreme bearishness are usually times where the market makes a pivot.
What does this all mean? What are you trying to tell us? What would the king be telling Chicken Little? Fair question, so here’s my answer. Fears are not facts. We always try to help our clients focus on long-term positive outcomes, while having to navigate through short-term negatives. If you are on the sidelines with cash, use this environment to your advantage. Mr. Fox is working overtime to keep you in cash and scare you into staying there.
We feel that cash is fine to hold for a couple specific reasons. For one, I encourage my retired clients to keep two years’ worth of portfolio withdrawal needs on the side at all times. That way, when markets roil, they can tap their cash reserves without having to harvest portfolio holdings at discounted prices. The other reason to hold cash is for strategic deployment when the market is down. Trying to time an exact entry point is extremely tough (if impossible), and only time will tell if the -21.5% threshold the S&P 500 hit on June 13th was the actual bottom. Nobody, repeat, nobody knows when the bottom will be hit, and attempting to figure it out is actually irrelevant for any investor. That is why you must be tactical and disciplined in deploying cash in down markets. You must pick a level and then commit. For example, if we hit down X%, I must invest Y dollars. If your investing time horizon is multiple decades (or more), you will be putting cash to work at discounted levels, and who doesn’t like a bargain?
However, there is a flipside to cash, and this is where Mr. Fox is trying to get you! The hazard of holding too much cash for too long will equate to a lost opportunity to invest, and in an inflationary environment, it will erode your future purchasing power. Down markets tend to discount much of the negative economic news upfront, and markets tend to start going back up long before the economic issues (that knocked it down) are resolved. That is just the perversion of markets. The steeper and faster the downturn is, there tends to be a mirror image of the slope and speed of the market recovery. I know Mr. Fox is in your ear right now, but don’t listen to him for too long.
Please remain comforted in the fact that our research efforts here at Hodges are constant. The stock market to us is a market of stocks, and regardless of the environment, there are always opportunities to find great ideas, and when markets correct, some of those ideas are now on sale.
Market tops and bottoms are made by emotion, not fact.” - Jim Weiss
Hodges Private Client is a program offered through Hodges Capital Management, Inc. (“HCM”). HCM is an Investment Advisory Firm registered with the Securities and Exchange Commission (“SEC”), is a wholly owned subsidiary of Hodges Capital Holdings and serves as investment advisor to the Hodges Funds. HCM is affiliated with First Dallas Securities, Inc, a broker-dealer and investment advisor registered with the SEC.
This discussion is not intended to be a forecast of future events and should not be considered a recommendation to buy or sell any security. Past performance is not indicative of future results. Investing involves risk. Principal loss is possible. Investing in smaller companies involves additional risks such as limited liquidity and greater volatility. No current or prospective client should assume that information referenced in this communication is a recommendation to buy or sell any security or is a substitute for personalized investment advice from your individual advisor. HCM does not provide tax or legal advice. Consult your tax or legal advisor for any related questions.