Among the succession of parties of families and friends of the last few weeks, I was able to glean some interesting information concerning the stock markets and their prospects. In particular, I had the chance to meet my two good friends, Messrs. Bull and Bear at a New Year’s Eve party. I thought I would share with you what they discussed:
Mr. Bull: Hi! How’s it going? It’s been a long time since we talked. How did you find 2022?
Mr. Bear: Fine, fine. Very difficult, can’t wait for 2023! Although I am afraid that 2023 will be another difficult year for the economy, for the stock market and for the geopolitical situation. For example, I don’t see how the war in Ukraine could be resolved quickly.
Mr. Bull: Sure. A lot of uncertainty hangs over the markets and the economy. But isn’t that always the case? Was there ever a time when you could invest in the stock market without uncertainty?
Mr. Bear: Probably not, but the current period is quite uncertain. I am thinking in particular of the high level of inflation which is likely to persist for several months. I don’t see the US Federal Reserve pausing its rate hikes for a long time. We don’t really see it yet in the economic statistics, but it seems obvious to me that such high rates will have a negative impact on economic growth. Frankly, I believe that we will see a recession in the first half of the year.
Mr. Bull: It is indeed possible. But wouldn’t a recession be good for the economy in the long run? Don’t we need an economic slowdown to finally curb inflation and bring it back to more normal and sustainable levels? A recession could, for example, alleviate the labour problems experienced in recent years.
Mr. Bear: I think so too. But I believe the economic downturn could be more severe and prolonged than most people believe. It is not so easy to control inflation when it is galloping. And that’s not counting the foreseeable drop in corporate profits. Rising rates will both decrease their revenue and put pressure on their margins—not a good recipe for future profits. Another big issue is the lifting of containment measures in China; we should expect a strong wave of COVID contagion and a significant impact on the global economy.
Mr. Bull: Okay. But we should not put all companies in the same basket. It is likely that companies that have not been profitable in recent years and that require capital on a regular basis will experience serious difficulties. Several of these companies may not even survive the next few quarters. On the other hand, many other companies are profitable and in excellent financial health. These should not only be little affected by the rise in rates but could also benefit from the difficulties of their less solid competitors. Nor should we underestimate the ability of companies to adapt to changing conditions in the economy.
Mr. Bear: I also believe that the market valuation is still too high, considering the rise in rates that has already taken place and especially the one that will come in 2023. This is even more true with a forecasted drop in corporate profits. The S&P 500 is trading at close to 17.0 times projected earnings for 2023. And that, in my view, is based on a forecast of nearly 13% growth in those earnings over 2022. That’s too optimistic.
Mr. Bull: You may be right. It seems to me, however, that after a 19% correction in the S&P 500 in 2022, it is safe to assume that most of the bad news has already been largely discounted. The market can certainly drop further, but the worst is probably behind us. Moreover, it is true that 17.0 times expected earnings is higher than the historical average of nearly 15.0, but the ratio must be considered in the context of the level of interest rates. Even though rates rose sharply last year, they remain low relative to their historical levels.
Mr. Bear: All I can say is that I have no confidence in stocks or bonds for the next year. I have taken a lot out of the market over the past few months and am keeping it in cash and deposit certificates. I’m sleeping soundly. In addition, the returns offered are beginning to be attractive!
Mr. Bull: Yes, but you do not consider the impact of inflation on your returns. In real terms, they will be negative. For me, it’s quite the opposite. I believe the stage is set for attractive returns in the years to come for the long-term investor. And this is true for both equities and bonds, although we must be selective and favour quality companies, those that are making profits and are in good financial health. I took advantage of the sharp market correction last year and am fully invested in the coming year.
Mr. Bear: Well, we will see. Despite all the bad news, I wish you a Happy New Year 2023!
I can’t wait to see my two good friends again at the 2024 New Year’s Eve party. When I left them, I couldn’t help but think that it takes all kinds of investors to make a stock market.
In the meantime, I wish you a Happy New Year! Health, happiness, and prosperity.
