What a difference a few months make. In December, the market was crashing. We had one foot on a bear market and the other on a pile of Vaseline. Since then, the market has rallied 21% in less than three months. The S&P is up over 13% so far this year and is now just 3% off its all-time highs, established last September.
The market came within a whisker of a bear market, down 19.8% (on a closing basis) from the September high. The crash took less than three months, between October 3 and December 24, and has recouped nearly all the losses in the less than three months since.
What happened?
The market completely changed personality, from bust to boom, with only one tangible change: the Fed. The global economy still stinks. We still have a trade war with China. It’s still an open question what earnings growth will be like this year. The bull market and the recovery are still long past the age of historical reckoning. Thus, it is the Fed alone that represents the only real environmental difference in the tale of two markets.
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The Central Bank announced a policy of “patience” going forward, putting rate hikes on hold for the time being. Prior to that it was assumed the Fed would continue to raise the Fed Funds rate at least twice this year. Without the Fed raising interest rates, the market believes the next recession got pushed further into the future.
Now what?
Three Possible Market Scenarios
The way I see it there are three possible scenarios going forward. One is that the U.S. economy succumbs to the aforementioned pressures and slows considerably. That wouldn’t be good. It would put a near-term recession and bear market back on the table.
Another scenario is that the economy exceeds current expectations. The problem with that is that it may cause the Fed to start hiking rates again. Either the economy sputters all by itself or the Fed will induce decline.
The other possibility is that the economy performs well enough to stay out of the doghouse but not well enough to reignite the Fed. That’s probably the best-case scenario for the market, unless the economy booms and the Fed still doesn’t raise rates, which is possible but not likely.
Of course, the market has a way of confounding expectations in the near term. It might do better than anyone thinks. Even if it doesn’t there could be trading opportunities along the way. But I have a hard time seeing how it has another 100% or even 50% move higher before the next bear market.
Consider this: Let’s say the S&P 500 finishes the year up 20%. That’s a great year! But that would mean it goes less than 7% higher over the next nine-plus months after moving up 21% in less than three months.
The point is that it is unlikely that you will be able to ride the market crest to high returns going forward. Odds are things will get ugly again before they get great again.
That isn’t as bad as it sounds though. The next bear market is unlikely to be nearly as bad as the last one, where the S&P 500 crashed 57% from peak to trough. That was highly unusual. In the absence of a major bubble or skyrocketing inflation the typical bear market historically has not been much worse than the selloff we saw in December. And how hard was that to endure if you stayed the course?
A strong market is a tailwind for any stock. But many stocks thrive despite the performance of the market indexes. There are several individual stocks that are still selling at bargain prices—with high dividend yields—that can thrive in a sideways or even a down market.
Sectors for a Stock Picker’s Market
Right now, the more cyclical sectors like Industrials, Technology and Materials could perform well in the near term but are increasingly dangerous in the intermediate term. Defensive, more recession-resistant sectors like Utilities and REITs are great in a late-cycle environment like this but many of the best stocks are expensive and near their 52-weeks highs. The Energy and Financial sectors are still cheap despite the recent run-up and there are some great values worth getting.
Other stocks may not be in the ideal sector but offer specific and alluring value, along with high dividend yields, that can be excellent investments in this environment. In my Cabot Dividend Investor advisory I highlight several such opportunities. There are still great opportunities in this market. They just reside in different places than they have in the recent past.
And if you want to know what investment opportunities I’m recommending these days, click here.
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