So much the the summer doldrums! 2022 continues to throw us twists-and-turns we haven’t seen in quite awhile. Interestingly, these types of swings in the markets are actually more normal than what we have experienced in the past 10-12 years since the Great Financial Crisis of 2007-2009. It was then that the US Federal Reserve really turned on the free money spigot to bail out the ills of the financial system.

Of course, this wasn’t an anomaly brought on by unknown forces. To the contrary, it was a self-inflicted wound caused by greedy finance people! I know this comes as a big surprise, right? That capitalism is highjacked by a few self-serving opportunists who then cause us all to suffer. History tells us that the human beast is likely to repeat this process, unfortunately, and we will continue to debate the lack of consequences for the bad guys and the right way to fix these problems to come.

So the markets enjoyed more than a decade of pure bliss, aside from a couple 2-3 month periods of downturn here and a summer there. In a sense, we have been lulled into complacency where things only go up in value, never down. We had plenty of reason to adopt this outlook given the Fed had our backs, and inflated the price of just about every asset on the planet. However, actual inflation as measured by the government’s CPI stayed shockingly low. The Fed itself kept an easy policy around money and financial support of the markets because their invention seemed to keep the economy on its feet with no real downside.

Residential Real Estate

So, why not drive interest rates on houses, for example, to 2-3% on a 30-year mortgage if nobody minds? The developers and house-flippers sure loved it! Clearly, this was not sustainable and now we are seeing the negative results in full color, let alone the massive wealth gap that they sparked. Half of America lives hand-to-mouth, and cannot borrow or even afford a home of their own, so they are forced to rent.

Today, given the nonstop rise in rents and housing affordability at an all-time low, the Fed is very focused on bringing prices down, and they will. They know the US will see riots in the streets (rightfully so) if you raise rents 10-20% every year. This must stop, and we are finally waking up to the fact that the government has again sparked a massive bubble in housing and the real question in real estate is how the downturn in prices will evolve; a slow-and-steady decline or a trap door where we’re suddenly down 20-30%.

Our view on residential real estate is that we have definitely seen the top for quite some time, yet the Fed is still in control so a slow bleed is our base case as of today.

The Stock Markets

In late June, we published this piece, which turned out to be eight short days from what looks like the bottom in stocks:

Finally, one of the interesting twists to the markets this year is that we have seen several times where the mostly negative news flow has not translated into lower prices. This happens with investors go to an extreme in either how confident they are, or how bearish they feel. It doesn’t happen often, and can cause many – even professionals – to sit back and scratch their heads in wonderment.

Most recently, the indicators that we watch for signs of too much buying or selling are very strongly signaling that there has been too much selling, and a rebound of significance is close at hand. The set up we see across many areas that we watch are telling us that, despite the potential for things to get worse with inflation, the war in Ukraine, a possible recession, etc., a lot of selling has already been done and the risk/reward to holding or even adding to stocks is favorable.

So, we find ourselves negative on the news, yet positive on the markets. This phenomenon may not come around for years, but when it does, history tells us that a bull market in bearishness can come to an end even when the world around us continues to look bad.

Since the low of mid-June, early summer  the NASDAQ is up a whopping +23%, the S&P 500 is +17%, and the Dow is positive by more than +13%! All of this in spite of continual bad news. Nothing has materially changed, except for investors’ belief about the future.

So take note, bottoms in markets don’t happen on a breath of positive news; they happen when the news is terrible and the future looks really bad as well.

Will this bottom hold is anyone’s guess, but in our view, enough selling and bad news has been priced in that even if the news stays ‘ok’ markets could continue to drift higher into the end of the year. No doubt, the negative Nellies out there will have a miserably time dealing with this positivity and thus, makes a decent 2nd half of 2022 all the more likely in our view.

2nd Half of 2022 (Summer)

To summarize, the markets are dealing with a sea change in the Federal Reserve and it’s meddling in the financial markets. They fiddled because they could, and now a perfect storm of circumstances here and abroad has awoken the inflation giant and cause the Fed to reverse course.

What many investors have missed in this process is the fact that things happen very quickly today. It doesn’t take months for the news of a tighter Fed to sink in, so we see rapid and meaningful declines in asset prices. So much so that the market clearly went too far to the downside, and is now trying to course correct. Thus, we find ourselves enjoying sunny skies even though the threat of bad news, unexpected bad news, and a terrible environment for stocks still looms large.

It would not surprise us to see the whipsaw action continue into the back half of 2022, although, unlike the first half of the year, nobody is contemplating the Fed raising interest rates aggressively unless they have been in a long hibernation. Today through the end of the year, we see a market grappling with a much slower economy, a tight Fed, but not as tight as was believed at the beginning of the year. The indicators that we watch to get a read on the health of the market are now neutral, and typically this is a time for head-fakes, false breakouts in either direction, and overall a sometimes frustrating market.

Stay patient and we will continue to keep you updated on our thoughts and observations — Have a great rest of summer!