Volatility, Capitulation, and Where We Go From Here

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Yesterday the markets experienced their worst day since mid 2020, with 95% of the companies in the S&P 500 ending lower and several large technology companies such as Tesla and Amazon ending the day down more than 7%. Stocks remain under pressure this morning.

The catalyst for yesterday’s selloff, in my view, was the Federal Reserve meeting on Wednesday. Although stocks initially popped following Fed Chair Jerome Powell’s comments that a 75bp rate hike is not in the cards, my sense is that investors remain concerned that the 50bp rate increase will not be sufficient to tame inflation. Accordingly, yesterday we saw a substantial increase in the benchmark 10-year Treasury rate to above 3%, which negatively impacted all growth assets including stocks and crypto.

As I’ve said in previous letters, in my view the financial markets are primarily driven by how reality compares to the collective expectations. As of yesterday’s close, the S&P 500 is 13.5% off of its January ’22 high, and the NASDAQ is 23.2% off of its November ’21 high. Given this selloff, I estimate that the market is pricing in a reasonable probability of imminent recession.However, as I indicated in my last quarterly letter, I expect any recession to be mild in nature.

Yesterday I was asked where and when we think the market bottoms out. It’s important to remember that the market is generally forward-looking and has already priced in what’s known: geopolitical unrest, supply chain disruptions out of China, a far less accommodative Fed policy, and difficult earnings comparisons. What’s less known is how long elevated inflation persists and how well the Fed policy efforts will combat it. I believe that the market will bottom out when inflation peaks.

If you ask most economists and strategists, the March 2022 Consumer Price Index (CPI) growth of +8.54% y/y is very close to its peak. If their estimates prove to be correct, and I am correct in that a decline in price growth is the needed catalyst to drive the market higher, then we are very close to a market bottom.

For some investors, any sign of capitulation in the equity markets can be a buy signal. A recent Bloomberg article defined capitulation in this context as investors “selling stocks for whatever price they can get, causing massive declines in benchmark indexes, with stock market volume composed almost entirely of declining shares.” Sound familiar?

Earlier this week Ray Dalio, Co-Chairman and Co-Chief Investment Officer of Bridgewater Associates, published this piece outlining the performance of “bubble stocks” and suggesting “that we’re out of a bubble.” Warren Buffett is buying more stocks than he has in years. As a value investor, I’m seeing increasingly attractive opportunities in companies that have solid fundamentals, strong earnings, and a positive intermediate-term outlook.

Nearly all of our clients at Evolve Investing are long-term investors, who have the ability to remain calm during periods of short-term volatility, which are a normal part of the investing process. If you have any questions about your portfolio or positioning, please don’t hesitate to reach out.