CWS Market Review – June 21, 2022

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The Worst Market Since 1932

The good news is that the stock market rebounded on Friday and today. The bad news is that that comes after a very sharp selloff. Last week was the worst week for the S&P 500 in two years, and this is the worst start to a year for the S&P 500 since 1932.

I know it’s painful, but to borrow from Hyman Roth in The Godfather 2, “this is the business we’ve chosen.” This is what markets do. Every so often, the stock market goes through a stretch where it can’t seem to do anything right. Fortunately, these periods don’t last long.

For prudent long-term investors, bear markets are very good opportunities. When other investors panic and sell, that usually offers a great chance to pick up bargains. In a bit, I’ll tell you about one of my favorites that just got an upgrade. Wall Street is the only place where a sale is announced and everyone runs out of the store screaming.

One of the important truths of the stock market is that it tends to rise slowly and drop off quickly. The old saying on Wall Street is that bulls walk up the stairs while bears jump out the window. Boy, is that right.

Today’s surge was a good example of a contra-trend rally. That’s a fancy phrase meaning all that stuff that’s been doing horribly did well today, and all the stuff that’s been doing well did poorly today. Bitcoin did very well today, as did Tesla. I’m not sure how long that will last. As we know, bear market rallies are common and mainly false.

You could even call this a “double contra-trend rally” because the previous trend was the opposite of the previous rally.

Confused? I don’t blame you. In this week’s issue, I’ll try to make some sense of what’s going on.

How to Break Down the Bear

Not only are bear markets sharp and quick, but even within bear markets, the most painful days are bunched together. The market crash of 2008 is a good example. I need to explain that I follow a slightly different chronology from convention.

I think it’s better to see the market blowup of 2008-2009 in three segments. There was the “initial selloff” from October 9, 2007 to August 28, 2008. Then came the “panic phase” from August 29, 2008 to November 20, 2008. Finally, there was the “retest phase” from November 20, 2008 until March 9, 2009.

The initial selloff lasted 224 days and the S&P 500 lost 16.90% (blue line). The panic phase lasted 59 days and the market lost 42.15% (red line). Ouch! The retest phase was 72 days and the market lost 10.09% (green line).

(There’s nothing official about those phases. I just made them up, but I think it’s a better way to analyze what happened.)

My point is that the panic phase was by far the worst of the worst. By no means do I want to ignore the other two periods, but those were fairly standard lousy markets.

Which brings me to 2022. I suspect that we just came through our panic phase. In seven days, the S&P 500 lost 11.9%. That’s slightly more than half of the entire bear market (-23.6% through last Thursday).

In plainer terms, it took more than 100 days to make half of our losses. It took seven days to make the other half. The panic phases are sharp and unpleasant, but they tend to be short-lived. It looks like we may be past ours. The hard part is that we’ll only know for sure in retrospect.

Historically, the worst parts of a bear market don’t happen at the start. More often, the pattern is that of a slowly rolling snowball that turns into an avalanche. That happened in both 1987 and 1929. As the small losses mounted, the panic spread and those small losses became big losses.

The market panic of two years ago is an exception. Once the world understood the gravity of Covid, the market quickly tanked. In March 2020, the Dow Jones Industrial Average had two of its worst five days in market history. There’s a famous Variety cover from 1929, “Wall St. Lays an Egg.” The market drop of March 16, 2020 was worse than that.

The Fed Holds the Key

How much will the selling go on? That’s impossible to say. The Federal Reserve holds the key. Since 1950, the S&P 500 has had 17 drops of 15% or more. Of those drops, 11 times the market reached its low as the Fed started to lower interest rates.

For now, the market expects the Fed to hike rates by another 2% before the end of the year. As long as inflation is a threat, then pressure will be on the Fed to raise rates, and there’s no sign that inflation is abating. Companies are feeling the pressure. According to FactSet, 417 companies mentioned inflation during their Q1 earnings calls.

What really spooked the Fed was the recent report from the University of Michigan on consumer sentiment. It said that households expect inflation to run at 3.3% for the next five years.

This is major a concern because so much of inflation is self-fulfilling. When consumers expect inflation, they get it. Jerome Powell talks a lot about expectations for inflation. Once expectations take hold, they’re not so easy to change.

The unpleasant reality is that the Fed has a very poor track record of attacking inflation without causing a recession. To a limited degree, you can say that may have happened in the mid-90s. Outside that, the evidence is not in the Fed’s favor.

I don’t think an economic inflation is imminent, but the odds of one starting within the next 12 months are high. Goldman Sachs just said it placed the odds at 30%, but that’s an increase from where they had it at 15%. For a recession within two years, Goldman placed the odds at 48%. Historically, stocks have fallen 24% during recessions. We’ve nearly done that without a recession.

Church & Dwight Is an Ideal Defensive Stock

Recessions are Wall Street’s most honest auditor. That’s when you really see which companies are strong and which are not.

Recessions also reveal which companies are closely tied to the economic cycle. During a recession, you want to make sure you own plenty of defensive stocks. These are businesses whose fortunes don’t depend so much on where we are in the economic cycle.

Speaking of defensive stocks, we had good news today for one of the best defensive names on our Buy List. Shares of Church & Dwight (CHD) were upgraded by Wells Fargo. The firm raised CHD to a buy from neutral.

Like so many other stocks, CHD has struggled this year. At the start of the year, CHD was close to $105 per share. Lately, it’s been as low as $80 per share. Wells Fargo said that its stable of businesses is poised to withstand any setback in the economy.

Church & Dwight is about as defensive a stock as you can get. The company makes condoms and baking soda. When will that lose demand?

For Q1, Church & Dwight had earnings of 83 cents per share. That beat expectations of 77 cents per share.

For the year, C&D sees earnings growth at the low end of their 4% to 8% range. The company said that’s due to the pressures from inflation. For Q2, CHD expects sales growth of 5% to 6% and earnings of 70 cents per share. I think they can beat that.

While CHD has been selling a lower volume of products, thanks to price increases, revenue is up. Last quarter, net sales increased 4.7% to $1.28 billion.

Thanks to the upgrade, shares of Church & Dwight rallied 4.6% today. The next earnings report is due out late next month.

If you want to learn about the other names on our Buy List, then please sign up for a premium subscription: $20 per month or $200 for the whole year.

That’s all for now. I’ll have more for you in the next issue of CWS Market Review.

– Eddy