Third Quarter 2022 Stock Market Commentaries

S&P 500 traded off 4.88% during the third quarter of 2022. It marked three quarters of consecutive decline for the index. For the year, large cap stocks are down 23.87%. Smaller market cap stocks and technology heavy NASDAQ index are all down more than 30%.

Since the beginning of the year, we have positioned our portfolio mostly in cash. We are fortunate to have avoided this wealth destroying calamity. Given the magnitude of the current drawdown, it is natural to ask if it is time to increase our stock allocation?

I hear two arguments for buying stocks. The first is valuation has become reasonable. We strongly disagree with such assertion. 2021 was a stimulus driven earnings anomaly. 2022 and 2023 earnings estimates have yet to fully reflect a normalized picture. Economic slowdown evident in leading indicators would further subtract from the estimates. In addition, the experience of the past 40 years had been a continuous retreat of inflation and reduction of interest rate; hence the averages that reflected this environment may no longer be applicable in a more inflationary world. During the inflationary 70’s, stocks routinely traded at price to earnings ratio below 10.

As financial stress around the world becomes more acute, the calls for the Federal Reserve to stop raising interest rate and possibly reverse course have also grown louder. A Fed pivot will indeed cause a stock rally at least in the short term. In our assessment, global economic stress has not reached so painful a point as to cause the Fed to pivot. Members of the Federal Reserve are aware that any premature change of policy will probably lead to the return of inflation as soon as the economy starts to grow again. Indeed, even if the Fed pivots, we believe the rally will be short lived as stocks are yet to reflect incoming earnings recession.

Cash is a depreciating asset, so it is unsuitable as a long-term holding. At present, it is still the best choice among a range of bad choices. As the 2022 financial crisis unfolds in real time, having it will make all the difference.

Dong Hao Zhang

President & Chief Investment Officer

Evla Hills Equity Services, LLC