Reset Period Underway

July 25, 2022

The current ‘Reset Period’ has not been fun for many. Since the December 27th peak the Nasdaq Composite and S&P 500 Indexes have declined 25.2% and 16.6% respectively through last Friday.  During this period investors have been re-evaluating their risk temperament and rediscovering the benefits of greater diversification. Initial Public Offerings (IPOs) have also declined by about 75% this year as compared to the 2021 pace. 

Even the private markets are adjusting and risk premiums are rising. Private companies at all stages of investment are experiencing more difficulty accessing liquidity, especially in the venture area. Sponsors are encouraging “belt tightening” and layoffs are beginning to rise. 

The real estate industry has been feeling the pinch too. Rising interest rates are challenging borrowers.  Lenders are requiring more equity to support borrowings – something we haven’t seen for over a decade. At the “deal trough” commercial real estate brokers are seeing a rising rate of buyers walking away from contracted deals either because they cannot get financing or do not believe they can make the numbers work. The sudden rise in rates is also impacting hedging costs for borrowers. What used to cost only $30,000 for an interest rate cap on a multifamily bridge loan is now costing $1 million. Owners might be in for “sticker shock” when they have to refinance their development bridge loans. 

Last Friday a client asked if now was a good time to put some more cash to work in the stock market. Of course nobody knows but easing in through dollar cost-averaging is one approach.  Any discussion of the markets needs to include the extent of Fed policy tightening; assessment of market valuations; and expected growth in corporate earnings. Most of the news on Fed policy might already be priced into values. The Fed meets this week to deliberate on policy. Market expectations are there will be another 75-basis point increase. Investor sentiment seems to have pivoted from bad inflation news to possible slowing growth (soft landing) and even a looming recession (hard landing). Stock multiples have adjusted accordingly with forward S&P price-earnings multiples now around 16x as compared to 21x in late 2021. The third area is expectations for corporate earnings and whether the “E” in PE will decline in a slowing economic growth scenario. Peak Q2 earnings releases are being reported in the next few weeks and this week alone will be almost 150 companies reporting results. So far analyst have been constructive on the outlook for corporate earnings, but forward guidance may talk down any enthusiasm. 

The good news is the market has bounced 8-11% since the June 16th low.  An old codger once said to me that “trees don’t ever grow to the sky” and that was good thinking last fall.  However today, a good gardener knows best to pinch off dead growth to encourage new growth.  Perhaps this Reset Period, or adjustment in values, will make for better investing times.  Steady as she goes. 

Gary B. Martin