July 22 - The Rebound?
A prominent financial investor/columnist wrote last week, "the current environment is one of the most challenging I can remember." This person has been involved in the markets for slightly less than 20 years and is generally an excellent writer. But that quote is one of the most overused comments made by market participants. While there are rare periods of smooth sailing, most market environments present unique challenges that generate risk and worry. The uniqueness of this period stems from the Federal Reserve tightening in the face of a bear market in the equity market, a recessionary style economy, and high inflation. In the last eight bear markets, the Fed has responded by cutting rates, but not this time, not with excessive inflation. Inflation is the number one enemy, and rightfully so.
After the worse starting six months for the equity market since Nixon was in office and the worst start for the bond market since returns have been recorded, it was unsurprising that a relief rally occurred in July. In mid-June, 98% of US large-cap stocks were below their 50-day moving average, a sign of an extreme oversold condition in the equity markets. More than anything else, the severe negative sentiment at that time prompted the recent rally.
The relief rally most benefitted the areas that the decline had hardest hit. Mega cap stocks led the way, with the top 5 companies in the S&P 500 (now carrying 23% weight) returning 19% in July, pulling up the market cap indices. These stocks, the kingpins in 2018 through 2020, had recently suffered due to their valuations. Value and lower volatility equities, significant performers thus far this year, did not keep up with the overall market in the past month. This weighed on Versatile's equity performance in July. Additionally, International Equities, which increased by only 5%, and Emerging Market Equities, which were flat, also were a drag on performance.
Wall Street and financial news heavily emphasize our need for certainty by attempting to tell us what will happen to the economy and the markets over the near term. Academics have demonstrated this is futile, yet the appetite for this information persists. What academics know is that the equity premium is strong over the long term and that there are specific drivers of returns for equities that increase the odds of investment success. Versatile adheres to this academic approach.