You don’t need me to tell you how fragile the mood on Wall Street still is, a full 16 months into the bear market and a year into the most aggressive Federal Reserve tightening campaign in nearly two decades.
The Fed is still moving fast enough to break things. And with cracks emerging in the banking system, we’ve seen promising rallies stall as investors shift focus away from the great things innovative companies like ours can do in the future and revert to obsessing over all the things that can go wrong.
When existential threats loom large, nobody wants to bet on brighter days ahead. Before you start dreaming of a better tomorrow, you first need to have at least a little confidence that there’s a “tomorrow” coming at all. Investors who lose that confidence are probably better off leaving the market altogether and parking in money markets until they recover their nerve.
But I have to say that what amazes me right now is how resilient some investors and some stocks still are. A lot of growth names are doing really well, while the rest remain stuck in the gloom that dominated the market last year. That’s not an ideal situation . . . but week by week, across all the recoveries and relapses, it’s getting incrementally better.
And I think this earnings season will decisively shift sentiment in our favor. The early numbers are getting just enough traction to show us that we’re not the only people who love our stocks and appreciate what they can do once the Fed gives us a chance to catch our breath.
It’s a little perverse but for the last 16 months, Wall Street has been running scared from all forms of risk ahead of a recession that has yet to be formally called or even hinted at in the data. A lot of people are so nervous about nightfall that they’ve spent months dumping great stocks in broad daylight.
There are two ironies here. First, while stocks priced for perfection need to come down hard when the economy breaks down, our stocks have already come down hard. They’re priced for a coming breakdown and every day forward takes us closer to the recovery beyond, when these companies will have more daylight on their side.
The second irony is that opportunity cost is a form of risk. Wall Street doesn’t relish throwing money away on little companies that can’t survive a downturn . . . but sooner or later, enough little companies always find a way around the obstacles that shareholders are amply rewarded. Shutting yourself out of that story means shutting yourself out of the good things the market can do.
Or in other words, you can’t hide from risk forever without dramatically reducing your ultimate return profile. This is a basic lesson of life . . . maybe one of the most important ones for investors.
And right now, Wall Street is actually in the sweet spot. A few growth-oriented companies have reported some challenges and a little pressure, but they aren’t collapsing. They’re cautiously optimistic, realistically confident that they can roll with the punches and keep executing on their plans to disrupt established markets and create new ones.
After all, they’ve been rolling with the punches since the Fed stopped flooding the world with free money. If they didn’t die in the pandemic, they’re unlikely to crumple now. They’re not flashing clear signals of distress.
Neither is the economy. Inflation is cooling, giving the Fed room to show a little mercy if layoffs spiral out of control or if the banks cave in. GDP growth is sluggish but in real (post-inflation) terms remains positive. That means wealth is still being created faster than price pressure takes it away.
It might not feel great but it’s a lot better than the negative real growth we endured in early 2022. And that was a full year ago. We survived that slowdown, which might or might not ever go on the books as a formal recession when the government’s economists weigh all the numbers.
By the time the government calls the next recession, a lot of companies have what it takes to be 10-50% bigger on an earnings basis than they are now. The ones that look rich relative to the market as a whole will grow into their valuations on the way to higher share prices. The ones that already look cheap will be practically irresistible.
Which type of investor are you? Do you see this scenario as exciting or are you exhausted? Let me know where you stand. Because everything I see suggests that the market is at a crossroads where some investors go one way and the rest go the other.
As for me, I’m a “glass half full” type. Not because I’m inherently optimistic or cheerful but because in my experience you can’t protect your wealth by locking it up (or hiding it under the bed) . . . there’s always a threat, even if it’s as faceless and eternal as taxes, inflation or ultimately death.
The way to defend what you have against these factors is to keep it working. That’s what money wants. Capital wants to circulate. It wants to fund activities that breed more money and create wealth.
And above all, it wants to earn a rate of return big enough to keep ahead of the threats. We all need to earn more than 4% right now just to keep ahead of inflation, let alone taxes. You can’t do that if your money is under the bed with its buying power deteriorating every day.
The glass has to be half full in that scenario. Or more to the point, you need to go looking for what the glass is half full of, where the hot spots are in an otherwise stagnant market. That’s where you find leverage. And given enough time and willpower, that’s where you thrive. We might not like it. But this is the way of the world.
And in an expanding economy, believe it or not, the glass is constantly filling up to the point where we need a larger glass. Earnings growth is real. Corporate managers as a group find ways to make their companies more valuable, which supports higher share prices and, again, creates wealth.
That’s capitalism. It’s the American Way.