The Unseen Entanglement Shows How Stocks’ Recovery Should Look

The Unseen Entanglement Shows How Stocks’ Recovery Should Look

When world stocks and the S&P 500 entered an official bear market on June 13, it prompted a flood of fearful headlines proclaiming worse ahead. Overwhelmingly pundits see the post mid-June uptick as a bear market rally—and one sure to fizzle into a deeper decline. Perhaps. But as I detailed in May, now is no time to fall prey to The Great Humiliator’s tricks and fearfully sell. It is a time to position for the future recovery. Here I explain why it is most likely led by growth stocks.

Yes, this decline officially became a bear market in June. Yet as I’ve written?recently, nothing about the -20% threshold magically changes what you should do ahead. Investment decisions must be forward-looking—not backward. Being here now doesn’t imply big downside ahead or a long decline. The perception otherwise is false.

Since MSCI World data start in 1969, the median time from piercing -20% to a bear market’s low is a month. The median drop to the bottom after that -20% threshold is only -7.6%. Now, these are just medians—the midpoint of all observations. And they don’t predict. But they debunk the common notion that being in a bear market automatically means much more downside looms. They suggest the rally is close, if not here already. Selling risks missing it—and turning this year’s disappointing market returns into much harder-to-recoup losses.

Positioning for the Recovery

Ordinarily, economically sensitive value stocks lead bear markets down, as recession worries lead many to fret their survival. They then traditionally bounce big in new bull markets—initially, a relief rally based on the most catastrophic worries failing to materialize. But since January’s global high, world growth stocks’ -23.5% plunge nearly doubles value’s -12.1%. Some call it a “regime shift,” claiming lofty valuations and rising rates killed growth stocks’ decade of dominance—with value poised for lengthy leadership. No! The simpler, unseen truth: This year’s value strength hinges on bearishness. It is almost all about up versus down. On down days growth lags badly. On up days it leads markedly—and vice versa. There have just been more down days.

Consider: Through July 22, US stocks rose 62 days this year. Growth beat value 82.3% of those days. Stocks fell 77 days. Value beat growth 79.2% of them. This trend is fully global, too. Over the same span, world stocks rose 64 days. Growth topped value on 73.4% of them. World stocks declined 81 days. Value led on 75.3% of those. This is a very tight fit. The marriage of stock style and market direction is an unseen entanglement hiding in plain sight.

Growth, Value and Today’s Cavalcade of Concerns

Sentiment underpins this. As I’ve written here recently, this downturn is unusual due to the myriad scary stories driving it. Most steep downturns feature one or two big ones, like 2020’s COVID lockdowns or 2011’s euro crisis and US debt ceiling fight. But today there are many, at least seven, scary stories. None are huge alone, but like swarming bees stinging you they have taken turns dragging down markets all year—especially growth stocks.

Take rising rates. Many argue they decrease future earnings’ value—whacking growth stocks, whose sparkly profit projections draw premium valuations. Now, this relationship is mostly myth. Since 1973, world Tech stocks have outperformed in over half of years when rates rose. But rising rate fears hit them this year regardless, by sapping sentiment. Conversely, higher rates may benefit value-heavy Financials. The strong dollar, meanwhile, has investors sweating multinationals’ overseas sales are set to take a huge hit—especially Tech’s.

Other fears—like sky-high energy prices amid ongoing Russian gas supply uncertainty in Europe—directly benefit the value-dominated Energy sector. Recession fears likely aid defensive Utilities and Staples. Those three sectors lead US and global markets in 2022.

But their leadership shows you forward-looking markets pre-priced these factors. Meanwhile, overlooked positives percolate: the overlooked but mildly positively sloped global yield curve, America’s accelerating oil production, robust loan growth, the eurozone’s post-lockdown service sector rebound, spiking global travel and China’s broad reopening (with resurgent regional lockdowns easing, too).

What Goes Down …

All this favors pummeled growth stocks. Since 1970—when sector compositions changed to more accurately reflect present configurations—US bear markets’ worst-performing sectors have fairly consistently rebounded strongest. In the seven bear markets since then, sector returns during the downturns had a median correlation of -0.73 with returns six months post-bottom. Given 1.0 means lockstep movement and -1.0 is polar opposite, this shows bear market laggards normally flip to leading—fast, strong and long. While I can’t be sure mid-June’s lows are the bear market’s bottom, the upturn since fits the pattern: Growth stocks are more than doubling value.

Typically, what falls the hardest bounces highest in the initial recovery—and for a long time. Again, that argues for growth stocks’ resurgence—and shows you which categories to target now. From January’s highs through June’s lows, the Consumer Discretionary, Communication Services and Tech sectors were the three worst-performing global sectors—all down over -29%. Key growth industries have fared worse. World Tech-like Internet and Direct Marketing Retail firms and Interactive Media companies plunged -38.9% and -34.7%, respectively. Luxury Goods firms slid -34.9%. Those big declines tee up big rebounds. Again, I can’t be sure this upturn is the recovery yet, but overall those categories have led since mid-June.

If I’m wrong? Value stocks still look risky. If this is indeed a bigger and longer bear market, then a big recession looms. And, if so, oil and commodity demand will tank. Commodity producers and basic industries would be crushed. Credit could very well freeze, squashing bank profits. Economically sensitive value firms would suffer broadly.

In markets, myopia is misery. Hard as it may be, now is a time to look forward to the growth-led recovery that is likely brewing underfoot.?