5-24-22: What Happened to Risk Assets in 2022?

by Jason Bodner

May 24, 2022

Looking at risk asset markets these days is enough to cause severe nausea. Inflation fears have pushed growth stocks into discounts where valuations are getting silly. Tech stocks are getting so hammered that one might think we’re headed back to the stone ages. Far from it… consider this: Musical birthday cards have more processing power than all of the Allied forces combined in WWII. Granted there weren’t many computers back then, but still cell phones have more computing power than NASA’s moon shot in 1969.

With tech stocks so unloved that many are selling, Moore’s law and market history say that’s a bad idea.

We will only become more reliant on technology as time goes by, so what’s hammering the sector isn’t sentiment, or logic. It’s margin debt reduction. Let’s look at prior periods of similar market pressure.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The spectacular fall of the 1999 dot.com bubble was based on insane valuations. Many stocks traded at infinite multiples, meaning P/E ratios based on zero earnings! That bubble needed to be popped, as painful as it was. But when rates were low, and margins went up, so did equity prices. Then they both fell.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Next, look at the 2008 financial crisis. Greed for higher yields drove Wall Street to innovate. They packaged risky home loans into structured products and sold them to pension funds and conservative investors. The basic assumption was that house prices would only increase. That bubble also needed to be popped, as painful as that was. But look again at the correlation between rising margin debt and equity appreciation. Then the pop, then the fall of stocks coincided with the reduction of margin debt:

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Our current market volatility doesn’t compare to either of those or even the threat of COVID-19: 2022 is fear over an economic slowdown and inflation uncertainty. Company valuations have fallen to deal-like levels. That’s because this correction doesn’t have many stocks with infinite valuations. Nor does it have risky high-fail-rate loans in conservative investments. What we do have is a need to unwind leverage.

Margin debt balances (money a broker lends you to lever up your principal, at 2:1, 3:1, or higher ratios) has reached nosebleed levels. This is because the government gave away free money and offered to lend at effectively zero interest for years. Now, this loan bubble is unwinding, forcing stock prices lower:

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

We all knew the party wouldn’t last forever, and nobody wanted it to end. But the cops are now here, and investors are scrambling for the exits. The good news is that, once margin calls and leverage reductions conclude, which should coincide with an oversold BMI, the market will find a floor. Once there are no sellers left, value buyers will step in. Speaking of the BMI, we should hit oversold Monday this week:

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Look what happens historically when this happens. Here we see each instance of oversold and the average forward returns for 1, 3, 6, 9, 12, and 24 months. From this data, the trough could come by around June 1.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Another great indication that we are close to bottom is that Warren Buffett is on a buying spree. He just took large positions in large-cap energy, financial, and tech stocks. Warren doesn’t buy at tops, only near bottoms. So, we have a near-oversold BMI, falling margin debt balances, over 50% of the NASDAQ down an average of 57%, and Buffett buying! That’s why I believe we’ll start to see stocks lift in June.

That said, in an immediate inflationary environment, energy, food, and staples are poised to benefit. I expect when forced selling concludes, tech will bounce, albeit not to new highs, and energy and staple stocks will fall. But this will likely only happen for a period of 1-4 weeks. I don’t expect a tech bull market to resume until there is clarity on the economy.

Once it is clear that we have either avoided a recession – or weathered a short, mild recession – money will pour back into growth stocks. At that point, wherever interest rates have climbed to will likely have stabilized. I still believe this is possible in the third or fourth quarter of this year, which would give credence to my theory of ghost tightening. Remember that the target Fed funds rate is currently only at 75 basis points. I still believe that the Fed will raise interest rates only to pre-Covid levels in the mid-twos.

Fed “jawboning” caused falling asset prices, which in turn caused deleveraging in the form of margin calls, which actually helps the Fed. Add to that the fact that the highest sources of inflation are in the essentials, like food and energy, and the consumer is feeling the real effects of monetary tightening without their actual policy matching the fear levels. This is at its heart what I call: ghost tightening.

So, while I know it is miserable to sit through all these unknown outcomes at once, my advice is: “Don’t throw in the towel when the fear feels the worst.” That would be a grave mistake. After all, if the greatest investor of all time is buying right now, do you want to be the person that he’s buying from?

Years ago, when I ran an options desk on Wall Street, my Bloomberg terminal had a space where you could display a message for anyone looking up your name. It was 2008-2009, in a particularly dreadful time. I felt fear, but I knew I had to be strong for my employees and clients. A phrase kept repeating in my head: “Feel the fear and do it anyway.” That remains my mantra today, especially in this tough time.

It’s natural to want to succumb to fear, but doing so usually happens at the worst possible time. When things look worst, they can get worse (or turn better). But just like anyone who’s lived through a hurricane or a tornado or a “nor’easter,” the storm always passes.

As Kali Uchis says: “After the storm is when the flowers bloom.” 

(Note: Navellier & Associates is offering an expanded White Paper on this topic: “What Happened to Risk Assets in 2022?” by Jason Bodner. Link is available here.)

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Jason Bodner is a co-founder and co-owner of Mapsignals. Mr. Bodner is an independent contractor who is occasionally hired by Navellier & Associates to write an article and or provide opinions for possible use in articles that appear in Navellier & Associates weekly Market Mail. Mr. Bodner is not employed or affiliated with Louis Navellier, Navellier & Associates, Inc., or any other Navellier owned entity. The opinions and statements made here are those of Mr. Bodner and not necessarily those of any other persons or entities. This is not an endorsement, or solicitation or testimonial or investment advice regarding the BMI Index or any statements or recommendations or analysis in the article or the BMI Index or Mapsignals or its products or strategies.

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