HNY! The Wisdom and Folly of Market Forecasts
I started to think about the recession, how long and how deep, just as I fell ill with the flu.
Would my flu be a one-and-done (like the 3 month recession of 2020), or would it be a long deep affair of high temps, sleep, and a week lost (like the 200-2003 recession)
Maybe my flu is as good an indicator as any. It was long and deep (5 days in bed, 6 days an counting of fever - yup, writing you with a fever!)
The recession that follows one of the most aggressive interest rate hike patterns we have seen may be long and deep like my flu.
The best forecast for 2023 I saw was from Marc Andreesen:
If Billionaire futurist VC Marc Andreesen thinks forecasts are worthless, then why bother?
Here's why:
The value in the forecast is not in the accuracy, but in the learning. As I wrote in How to Spot a Market Bottom, the smarter experienced investors make shorter forecasts.
The longer the forecast, the bigger the errors.
But… the smart money doesn't abandon forecasts.
Instead, they use them to learn:
Start with your best estimate after you include data and intuition.
Gather data as time passes and compare it to what you expected
Adjust your estimate to your new best estimate
And your forecasts can be more exact (market to X level or down/up X percent) or market going up.
When we ride horses in dressage, the arena has letters. It seems arbitrary that you have to make a perfectly symmetrical 20 meter circle at the letter E. Why not a foot before or a foot after? Who cares if it's round?
The more precise the instructions, the more you know who is in the driver's seat.
If you just want a circle, you can fool yourself into thinking you are running the show if you get one. If you want a symmetrical 17 meter circle starting at E, well now you are going to see if you are actually running the show!
Same with markets. The more precise your forecasts, the easier it is to learn from them, even if it means you will be adjusting them more often.
BTW, we're never in control of the markets, only of our learning!
Today, I will cover:
Where we are today
The possible paths forward
What the bottom might look like
Where we are today?
This "feels" to me a lot like the first half of the tech meltdown in 2000. Nasdaq was down 40% in 2000, but down 80% by October 2002.
Last year, Nasdaq fell by 33%, but some of the higher quality names like AAPL still held up better than Nasdaq and far better than the work-from-home stars like Zoom, Netflix, et al.
Business closures, layoffs, and other economic indicators worsened at a faster rate in December vs November.
The Fed raised rates 50bps vs 75bps, but indicated they will continue on for longer than markets expect.
Possible Paths forward:
Staying with the smart money gives short forecasts, given the accelerated rate of layoffs and worsening economic numbers (Chicago PMI, etc) in December over November, I expect a record quarter of negative preannouncements in January 2023, just as we saw in January 2001.
What's different from 2023 vs 2001?
In 2001, I covered 300 companies, so had to get on 300 preannouncement calls, and then a month later, 300 earnings calls for the same companies.
Now my friend who is still in the business says companies just send out a press release with the negative preannouncement. Probably for the best since most companies were still figuring things out when they sent out the preannouncement, but this does lead to more volatility during earnings season as less information is in the markets.
After the preannouncements?
It normally takes at least 2 big resets (we had some misses in 3Q22) before we are back on track, and Q1 is a seasonally weak quarter even without a recession and higher interest rates. So, likely more negative preannouncements in Q2.
We can still see bear market rallies during 1H23 when markets get oversold on a short-term basis even if they aren't yet cheap enough for value buyers.
Just like in AI, there is a difference between a local minima and a global minima. Likewise, in bear markets, we often can see a localized bottom followed by a 30-50% rally, then roll over to lower lows on our way to the global bottom. These rallies may be worth playing if you have the personality and time to track markets closely.
Like grief, recessions are only healed by time.
Investors look at Year over Year growth rates. The first half of 2022 saw stronger growth. We will have negative preannouncements for the first half of 2023 as those are tough comparisons and we came into this year weaker.
However, with lower expectations and easier 2H22 comparisons, this could set us up for a market rebound in the second half of 2023.
This is exactly what we were expecting in the summer of 2001, and then the 9/11 attacks happened, which took the entire economy back down into a second cycle of fear and contractionary behavior.
On the other hand, 2008 saw a deep recession and even though banks were insolvent, FASB (Financial Accounting Standards Board), changed the rules for when banks needed to mark their assets to market, thus buying them time and ending the bear market on that same day in March 2009.
My forecast is a rough 1H23 with some rallies off oversold moments, markets lower by and zero visibility.
The flu/recession is looking deep with high temps. How long will it last?
The bear market will last until we hit the bottom (my easiest forecast of this entire letter!)
What the possible bottom might look like:
Bottoms occur when there are far more buyers than sellers.
We are not there yet.
We still need to wash out the enthusiastic dip buyer.
What I looked for in each semi cycle was the leader of that cycle, the "poster child". Markets are made up of humans. Humans like to see patterns, so then patterns in markets can become self-fulfilling.
History rhymes
All market bottoms in semis saw a mathematical drop in book to bill as bookings dropped off for everything but maintenance buys. But the first new buyer? It was always a different, yet similar pattern.
Who is the last bull market poster child?
My bet? Cathie Woods and ARKK ETF down 67% in 2022, and down 80% from the all time high.
All the while, she stayed on TV talking about broad concepts like "growth" and "the future"... and RAISED an additional $1.6B for her fund!
Yes, while her fund was down 67%, ARKK had $1.6B in NET INFLOWS in 2022.
When investors give up on ARKK in the form of net OUTFLOWS, that could be a sign of the bottom.
But both bottoms in 2009 and 2002 were also when value buyers came in, ie valuation had to come back to earth. This may or may not coincide with ARKK outflows, thus the ARKK outflow bottom might just be the start of a bear market rally and not the global bottom we are hoping for.
We, the smart money, will have to see what the environment looks like when we get there.