Looking for the Market Bottom
The author is a global equity strategist of Shinhan Investment Corp. He can be reached at park.sj@shinhan.com. – Ed.
Looking for the market bottom
Investor focus is now on finding the market bottom and setting up investment strategies for the start of a recession. Historically, stock market downturns began after economic and earnings shocks were confirmed amid growing uncertainties. In 2Q22, the global economy faced the worst inflation in forty years and the sharpest rate hikes in thirty years. As a result, real economic shocks and earnings forecast cuts are inevitable in 3Q22. At this point, it is still hard to accurately predict the market bottom.
Stock market to bottom out in 4Q on confirmation of damaged fundamentals
The difference between a deep or mild recession is whether or not the recession is accompanied by systemic risk. The average length of a bear market is roughly six months for a mild recession, and about a year for a deep recession. We will need to watch for signs of systemic risk in 2H22, but have yet to consider the possibility of a deep recession accompanied by systemic risk. Past trends suggest that we are already halfway through the current bear market. However, we also fear that markets could face strong headwinds preventing a shift to an actual uptrend in the near term.
Bottom-fishing opportunity: 3,600-3,700pt for S&P500, 2,200-2,300pt for KOSPI
We can also gauge the bottom of the stock market and the timing to bottom-fish stocks using fair price assessment. Unfortunately, we believe the stock market has yet to fully reflect recession concerns. Shares have corrected on the increase in valuation discounts but could fluctuate further on the down-adjustment of earnings forecasts, causing markets to remain volatile through 3Q22. Although difficult to fully assess the impact of complicated variables such as inflation, dollar strength and demand declines, we believe a bottom-fishing opportunity will emerge as the S&P500 reaches 3,600-3,700pt assuming 5-7% down-adjustment in 12 month-forward EPS forecasts. Similarly, a bargain-hunting opportunity is likely to emerge at home as the KOSPI reaches 2,200-2,300pt. Not to be confused as market bottom predictions, we recommend using these figures as a starting point when looking for bargain-hunting opportunities.
Asset distribution strategies at the start of a recession
Another point in focus is risk management and asset distribution strategies to consider at the start of a recession. We expect to see heightened market volatility in 3Q22 and differentiation among assets in 4Q22 before the economy gets back on a recovery track in 2023. Our projections are based on assumptions that credit risks and the Russia-Ukraine war do not develop into the worst-case scenarios. Still, we will need to carefully monitor any changes in earnings forecasts and credit risks going forward.
The key focus of asset distribution strategies has shifted from stagflation (growth↓, prices↑) to recession (growth↓, prices→). Bonds should be favored over stocks if monetary tightening slows down upon realization of recession risks. For 3Q22, we recommend cutting back on stocks, increasing weight in bonds, taking a neutral stance on commodities (alternative assets), and actively accumulating USD assets.
Equity strategy: OVERWEIGHT on G2; focus on quality & solar stocks
Despite widening fluctuations in share prices, we have yet to see definitive signs of an imminent upturn. For now, we prefer China and US stocks with a focus on quality and cash flows. We also recommend taking an individual approach when selecting sectors and investment themes after the 2Q earnings season. By theme, we recommend solar stocks as our top picks and urge investors to maintain a selective approach on platform and semiconductor stocks.
Retain BUY on bonds despite price burden
In our view, the phase of monetary tightening and rate hikes is now entering the final stretch. At this point, we prefer USD assets (developed over emerging market assets), government bonds (over corporate bonds) and long-term bonds. Meanwhile, a rise in policy rates above neutral levels could cause market volatility to rise once again, adding to the attractiveness of carry trade investments. In all, we recommend spreading out investments with a focus on long-term bonds.
Recommend a selective approach to alternatives
As for alternative investments, we expect to see differing performance among assets. We change our overall rating on commodities from OVERWEIGHT as a hedge against inflation to NEUTRAL on forecasts for increased volatility, albeit at different levels according to asset type. Inflows have notably slowed for private equity funds and venture capital funds due to discount rate hikes. Risk management is needed amid the rise in financing costs and increased focus on profitability. As for infrastructure, we are seeing active progress on investments for the restructuring of energy supply chains. In the near term, we expect to see clear advancements on infrastructure projects for energy storage systems in Europe and LNG terminals in the US.