This is not an economic or stock market crisis
With November election political campaigning in full swing, it seems like EVERYTHING is being characterized as a crisis these days. Border Crisis. Ukraine Crisis. Covid Crisis. Climate Crisis. Crime Crisis. Homelessness Crisis. Fentanyl Crisis. Inflation Crisis. Economic Crisis. These are a few of the things being characterized as a crisis in the current climate. Some of these are more severe and closer to crisis than others. What are not in crisis at this stage are the economy or the capital markets.
Are we in a bear market? Sure. Are we facing the potential of an economic recession? Yes. Is the housing market showing some signs of distress as rates rise? Yes. Could the market drop further? Yes. Is it fair to call this a crisis? Probably not. While it is always a possibility that conditions will worsen and we find ourselves in a deep recession as inflation proves difficult to tame, at this time it does not seem like the high probability outcome.
We have characterized this market as searching for a new equilibrium. With interest rates rising from all time lows, it is reasonable that stock PE ratios will drop…this is how stocks are valued. Stocks have indeed dropped this year as time has marched on. This is healthy because it gives companies a chance to grow into their valuations. Prior to this year, it seemed to us the market had gotten too far in front of itself after the covid-policy induced rally. Now we are coming back down to more rational levels.
While the dynamic has changed and the Fed is fighting an inflation battle for the first time in forty years, things have not reached crisis levels in our view. This has so far been an orderly decline without signs of extreme distress in the VIX index. Here is a long-term logarithmic chart of the market and a chart of VIX to put things in perspective:
As one can see from the charts above, there is nothing close to crisis-like conditions manifesting presently. While VIX is somewhat elevated, it has not spiked to its crisis levels of the past. Additionally, the market rallied last week in response to decent earnings and the hope the Fed would soften its planned rate increases. We have seen similar rallies since the beginning of the year. Have we seen the bottom? Probably not. How long could this process of finding a bottom go on? It could be another year. Will we look beyond this episode in future years as a normal part of the economic cycle? Likely, yes. In the meantime, make sure your risk posture is consistent with your risk tolerance.