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Jan 30, 2023

Bearish or Bullish, That is the Question

Christina Siegel Malbon

Investors started the year with extremely heightened pessimism, following the S&P 500’s 18% decline in 2022. Four-week outflows from US equity funds and ETFs totaled $58B at the end of December, a level not seen since the 2020 bottom. Calls of a looming recession reached heightened levels with the Conference Board estimating a 96% probability of a recession in the next 12 months in October. Plenty of strategists started the new year predicting more pain in 2023 with upbeat forecast hard to find.

Yet the markets are off to a strong start in 2023.  Is this another head fake in a bear market or are there good reasons for optimism?  We see growing signs this could be the beginning of a prolonged move higher.  A number of different market analysts have recently published data supporting strong market returns from here.

    • Birinyi, who we think has been one of the best long-time market prognosticators, believes that we are already in a recession with the market beginning to act like we have entered a bull market. Historical forward annual returns from similar starting points have averaged 47%, 20%, and 18% on a 1, 3 and 5-year basis.

    • Denise Chisholm’s, Director of Quantitative Market Strategy at Fidelity, research shows strong forward returns following periods of large market declines even when economic indicators, like payrolls, continue to worsen. Historical forward returns during these periods have averaged 20-25%.

    • Former Treasury Secretary Larry Summers, the most vocal critic of the Fed, has argued there was no historical precedent for a “soft landing”. He recently reversed course saying the odds of a soft-landing have grown as inflation readings decline dramatically and the job market remains resilient

    • Michael Goldstein’s work suggests the turn of the year could mark the bottom for what he calls the “Big Growers”, the 75 stocks with the very-best growth profiles in the large-cap market. From this starting point, the rebounds generally lasted for 1-3 years with double digit relative forward returns on average.

    • Ned Davis Research (NDR) sees a number of signs that indicate peak pessimism which have historically correlated to strong forward returns averaging 19-32%.

    • Bank of America shows investor positionings is at extremes, with equity holdings sitting 2.2 standard deviations below the mean while cash sits 1.4 standard deviations above the mean

The focus of commentators and investors alike is the likelihood of a recession and further market declines; however, Birinyi argues there is reason to believe that we are already in a recession based on the broad market declines of last year. Following periods where the market experienced both a bear market and a recession, forward annualized returns averaged 47%, 20% and 18% on a 1-yr, 3-yr, and 5-yr basis.

There is no one-size-fits-all definition of a recession with official identification not happening until after one has already occurred. While the number of leading economic indicators (LEI) entering recessionary territory continue to pile up, payroll data continues to lag catching more attention from the Federal Reserve and investors than might be warranted.

As Denise Chisholm, Director of Quantitative Market Strategy at Fidelity, recently highlighted, the magnitude of forward market performance is directly proportional to how poor recent market performance has been. Following periods of large market declines like we saw in 2022, forward annual performance ranges from 20-25% on average, even when economic indicators, like payrolls, continue to worsen . This makes sense as the market is a discounting mechanism and is already pricing in expectations of worsening indicators. As Bill Miller likes to say, “if it’s in the headlines, it’s in the price”.

But what happens when EPS is declining? According to Birinyi, 70% of the years that earnings have declined since 1970 have seen positive market returns averaging 19% over the same period. Furthermore, the focus on potential 2023 EPS revisions ignores the fact that operating earnings in 2022 declined 4% and 2023 consensus estimate have already come down 8%. Expectations impact behavior, which factors into price and future returns.

Even Former Treasury Secretary Larry Summers has begun to soften on the idea of a hard landing noting “I’m still cautious, but with a little bit more hope than I had before. Soft landings are the triumph of hope over experience, but sometimes hope does triumph over experience”. He highlighted the positive signs of inflation starting to cool even as the jobs market remains resilient. This is in stark contrast to 2022 when he said an economic recession was inevitable since job losses were necessary to rein in inflation .

All of this seems to align with the idea that we have entered into a new cyclical bull market. Birinyi believes that the secular bull market that began in Mar 2009 continues.  He notes that outperformance of the “worst” T12M performers relative to the “best” T12M performers is one of the more consistent signals for determining the end of a bear market. This matches with what we have seen YTD with the 50 worst performers of 2022 outperforming the best performers of 2022 with a YTD return of 18.8% vs 8.7%, respectively.

                                                                                                 Source: Birinyi Associates

Empirical Research’s Michael Goldstein, one of the best quantitative strategists in our opinion, maintains the turn of the year could mark the bottom for what he calls the “Big Growers”, the 75 stocks with the very-best growth profiles in the large-cap market. Empirical’s quantitative work shows the price declines in their “Big Grower” category reached the same levels in 2022 as they did after the tech bubble burst in the early 2000s.  Other quantitative signals suggest we’ve reached the end of the decline with current price-to-sales ratios reaching levels seen in other major growth stock bear market bottoms over the last six decades. From this starting point, the rebounds generally lasted for 1-3 years with double digit relative forward returns on average.

Furthermore, Ned Davis Research’s (NDR) leading indicator model has turned bullish for the first time since November 2021, with a reading of 70%, its highest since January 2021. This high reading provides a stronger base for the recent rally to be sustained compared to the failed attempts seen in March, May, August and November of 2022 when the reading oscillated between bearish and neutral zones.

Despite all these seemingly positive developments, investor sentiment continues to be excessively pessimistic, with NDR’s Crowd Sentiment Poll registering a low of 37.6 in September, a level not seen since the end of the 2009 collapse. While this reading has improved, it stills sits at extreme levels which corresponds to strong forward performance averaging 10% over all periods and 32% during secular bull markets.

Investor positioning also reflects pessimism with total outflows from equity funds and ETFs reaching $58B in December, a level not seen since the 2020 bottom. Historically, when we have seen equity fund and ETF flows as bad as they are today, the S&P500 has averaged returns of 24% on a forward basis.

According to Bank of America Fund Manager Study, equity exposure as of January sits 2.2 standard deviations below the mean while cash sits 1.4 standard deviations above the mean, a decision that can materially reduce an investor’s future returns. Looking at price returns on the S&P500 going back to 1928, an investor that missed the best 10 days (0.03% of days) would see their annual return over the last 95 years go from 5.87% to 4.68%. Missing the best 50 days (0.14% of days) would see returns fall to 1.73%. While losses can hurt emotionally, being out of the market on large up days is truly painful for returns.

No one can predict the future, but we know the market goes up 73% of 1-year periods, 84% of 3-year periods, 87% of 5-year periods and 93% of 10-year periods. There is always the possibility that we experience another pullback, but history tells us there’s reason for optimism and many smart observers see signs the worst is past.  As Sir John Templeton says, “bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.”


Big Growers: 75 stocks with the very best growth profiles in the large cap market.

The views expressed in this report reflect those of Miller Value Partners portfolio manager(s) as of the date of the report. Any views are subject to change at any time based on market or other conditions, and Miller Value Partners disclaims any responsibility to update such views. The information presented should not be considered a recommendation to purchase or sell any security and should not be relied upon as investment advice. It should not be assumed that any purchase or sale decisions will be profitable or will equal the performance of any security mentioned. Past performance is no guarantee of future results.

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