Is the Bear Market Over?

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Maybe those who have called the bottom are right and that everybody just got too negative. Inflation, dollar, Fed hawkishness. How do we see these two factors and who wins out? I tend to think this is still a bear market rally. Consumers in good shape.

Corporations are in good shape. So no, I don't see a hard landing.

Americans prepared for a severe recession. Welcome to the Barron's Streetwise Podcast. I'm Jackson Cantrell in for Jack Howe. Which of those commentators we just heard do you agree with? The S&P 500 is up nearly 10% from its low point in mid-June. Is this the start of the recovery we've been waiting for? Or is it a bear market rally waiting to bite those who buy too soon? Coming up, we'll hear from a chief market strategist and a value fund manager about what investors should do now. Our regular host, Jack Howe, will be back next week. In the meantime, I'll bring you a pair of fresh market perspectives while trying not to break anything important. Here to lend emotional support is Baron's producer Meta Lutzhaft. Hi Meta! Da da da da da da da. Is that the theme song to Rocky III: Eye of the Tiger by Survivor?

You're right.

Oh, I'm feeling pumped up already. Technically, tigers have ordinary daytime vision, so I always wondered if the song should instead be called Ears of the Tiger or Nose of the Tiger. And not to nitpick here, but in Rocky III, Rocky gets the daylights beaten out of him by Clubber Lang, played by Mr. T, and then wins the rematch, which is really just a break-even performance, but I appreciate the encouragement. Meta, are you there? Well, I still feel charged up. The economy still looks wobbly. The most recent GDP report out this past Thursday showed a decline for the second quarter in a row. Inflation in the US is still the highest it's been in 40 years. China is still shutting down cities due to COVID, and Russia is still waging war in Ukraine. Stocks, though, have been gaining ground for weeks. At one point this year, the S&P 500 was down 23%. Now it's just down around 15%. And with companies now reporting second quarter earnings updates, investors seem to be fairly forgiving of mediocre results and very rewarding of good results.

Certainly last quarter, bad news was punished aggressively, mercilessly. I think the one thing we've learned from earnings season so far is that investors may be a little less eager to clobber their companies and may even be willing to reward them.

That's Steve Sosnik, the chief strategist at Interactive Brokers.

You know, Netflix, yes, they lost fewer subscribers than feared, and their outlook wasn't good. But, you know, the market sort of went, okay, all right, we've seen worse.

If investors are shrugging off bad news, is that a sign markets have already reached the bottom? Maybe bad earnings results and a bad economic outlook are already priced in. And in that case, a rebound in stocks might not even need good news, just not as bad news. But Steve says investors who make that argument are missing the Federal Reserve-sized elephant in the room.

One of the things we like to say when the markets are going up is don't fight the Fed. Well, what are you doing now if you're aggressively long? You're kind of fighting the Fed. The Fed's not being friendly right now.

When Steve says don't fight the Fed, he basically means the Fed is raising interest rates to try to cool inflation. And that is likely to put a damper on stock returns. So investors shouldn't bet aggressively on stocks until the Fed changes course. And it's not just overt changes to short-term interest rates. The Fed can manipulate long-term rates by buying and selling bonds. For years, it made massive bond purchases to push yields lower and spur the economy. That's called quantitative easing, and it helped to produce big gains for stocks. But now the Fed has begun reducing its bond holdings. It's going slowly for now, and Steve says that's for good reason.

They're sort of tiptoeing into it a little bit, slow walking it, because I think they're a little afraid of what happens. We've had bouts where the Fed has tried to reduce their balance sheet, again, as I say, somewhat timidly. One of the times that they actually were raising rates while shrinking their balance sheet was late 2018. Which, by the way, we saw a bear market in late 2018. That ended when the Fed announced that they were not gonna raise rates anymore.

When might the Fed stop raising interest rates? On Wednesday of this week, it bumped interest rates up another 3/4 of a percentage point. Those last 2 hikes were the biggest since 1994. In a press conference, Fed Chair Jerome Powell said another 3/4-point hike could be necessary in September. The stock market, though, appears to believe the Fed won't be that aggressive, or at least won't raise interest rates for much longer. But Steve says the Fed might not be so quick to back down like it did in 2018. This time it has to fight high inflation. He says investors should be wary of making aggressive bets on the stock market until the outlook changes. Steve says to expect plenty of market volatility and that the recent rise for stocks might be an example of just that.

By the way, what we saw last week, sort of the jolt upward, that was also volatility. It's what my friend and longtime Barron's columnist Steve Sears likes to call socially acceptable volatility, but that's volatility too. If you have a 3% up day, everybody's kind of relieved, right? Oh, that was great. If you have a 3% down day, Oh my gosh, what's wrong? What are we doing? We like updates. We expect updates. Most people are long, but it means you have to expect volatility, and volatility works in both directions.

I asked Steve what increased volatility and a more restrictive Fed policy mean for index fund investors like me.

It depends on your timeframe. If you're planning to retire, you know, in a year or two, that may or may not be the right strategy depending on how much money you need. If you're in your 20s, By all means, if you like buying at 20% higher, who doesn't like buying things at a 20% off sale? That doesn't mean it can't go down before it goes up.

Steve says long periods of stock market stasis are normal. That can be surprising to hear for someone who's only invested in an environment where stocks tend to just go up. According to him, we might be entering a period where the market treads water for a while. Or with high volatility, I guess more like treads water in a wave pool. Hey Meta, want to hear a tip for treading water for a really long time? Do I? Jack told me this. It only applies if you're knocked off a boat and happen to be wearing jeans. What you do is you take the jeans off, you tie the ankles in a knot, and you could blow air into the waist of the jeans and hold the waist closed, and it will fill with air and kind of be like a life preserver. What do you think? What if you're wearing shorts? If they're knee-length, you might have a chance. Okay, so what if you have fashion jeans? You know, the ones with like tons of holes in them? Well, then you sink, but with style. Coming up: A longtime value manager shares a bear market survival tip that has nothing to do with inflating your pants and everything to do with bolstering your cash flow. That's next.

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Welcome back. We just heard from Steve Sosnik from Interactive Brokers. He's a fan of dividends, especially in this kind of market.

If nothing else, if you put money into a stagnant market but you can get a nice decent return from doing so, more or less paid to wait, that's really compound interest. If, you know, if you're sort of in a fund that's reinvesting dividends, or if you're in individual stocks and, and in a dividend reinvestment program, those dividends grow, you know, they'll grow your holdings. Right now on a trailing basis, the S&P 500 is about 1.6%, maybe not enough to make you excited. That's not so bad.

Jack recently spoke with someone else who likes dividends.

Hey, Jim, how are you?

Hi, how are you?

That's Jim Cullen. He's the founder and CEO of Schaefer Cullen Capital Management. It currently manages over $20 billion. He recently published a book, The Case for Long-Term Value Investing.

The dividend gives you some more cushion, but the interesting thing is going back the last 60 years, anytime the market's gone down and had a recession or a bear market, dividends on the S&P 500 have gone up during that entire period.

Jim started investing in 1961. He managed family money while aboard an aircraft carrier.

I came out of the Navy. I was a Navy officer managing a little money on an aircraft carrier.

Wait, hold on a second. How do you check your stock prices when you're on an aircraft carrier in the early 1960s?

You didn't worry about it too much even then. You know, the opportunity didn't get in that often.

Jim wasn't always attracted to dividend-paying stocks. When he left the Navy to work on Wall Street at Merrill Lynch in the 1960s, he liked the large blue-chip growth stocks in hot industries like Xerox, Polaroid, and the airline Pan American. He said the people at the firm who liked dividends back then seemed out of fashion.

They had 3 older guys there and they all had suspenders, red suspenders, smoking cigars, talking about dividends. Like their relatives, they call them Bessie and Ma Bell, what have you, and talk about the dividends. I said, the damn dividends must have something to do with suspenders and scars. So we made fun of them, right?

But then in the mid to late '60s, the kind of stocks that Jim and his buddies liked, known then as the Nifty 50, had a tough go of it. The Dow Jones Industrial Average wouldn't rebound for another 15 years. And during that time, the dividend payers came in handy, especially if shareholders used dividends to buy more stock. Now back to Steve Sosnick. I asked him what qualities should longer-term investors be looking for in stocks right now? He said no matter the time horizon, everyone should be thinking like a value investor to some extent and to focus on companies that generate cash.

Can you find sustainable earnings It's nice if they grow, obviously. Eventually you do want companies that are growing. Focus more on earnings and cash flow rather than sales growth. Because while you can't grow earnings without growing sales, you can certainly grow sales at the expense of earnings. And I think we saw a lot of companies doing that that became very popular 2020, 2021, only to find that may not be working now.

Did you catch that? Steve is saying that some growth stocks spent resources to generate more sales, even if it came at the expense of profits. For example, imagine a cell phone company that offers huge bonuses to new customers who switch to their service. The company might not make money on the new customers, but their sales will grow. Investors seem to reward that strong sales growth. But that might not be the case anymore. Steve says earnings are harder to manipulate.

Focus on operating earnings and focus on cash flow. It's really hard to fake cash flow. Again, that's kind of why I go back to cash dividends because you can't fake that. It's money, it's cash. I know that sounds like the most boring things to look for, but in a turbulent environment, that's kind of the rock you can cling to there. Yeah, you know, obviously companies will have surprises. You know, Walmart seems like a bulletproof company until they sort of have sequential profit warnings. Even so, I don't think they're going away.

A few last notes from Steve. He says to be wary of companies who borrow money to pay their dividends, and also that cautious investors should not limit themselves to value stocks. He says good deals can be found in growth too.

I'm going to tear up the script right now and say there really isn't a difference between growth and value. The big cap growth stocks are trading like value stocks, and they should approached as such. Some of them will be able to offer you very good growth at a reasonable price, and in many cases pay you a dividend. Other ones are still discounting a rosy future and perhaps the hereafter.

Trey Lockerbie: As for where you might find attractive dividends, Jim Cullen from Schaefer Cullen Capital Management runs a fund called High Dividend Value Equity alongside partner Jennifer Chang. Its top holdings are Johnson Johnson, Raytheon Technologies, and Philip Morris International. And its top sectors are healthcare, financials, and consumer staples. Jim says he tries to pick at least 2 companies in every sector for diversification. Jack asked Jim one last question. It was about the future of the stock market.

Hey, Jim, let me ask you about one last thing. You've been at this for a while, putting money to work, in America's businesses, and that takes a certain amount of optimism. But everything in the news, it's like crisis after crisis, even, even coming out of the pandemic, climate crisis, political division, people are at each other's throats, no one could get anything done. And it leaves a person thinking, can America still do great things? Like, if we're putting money to work in America's businesses for the next 20 or 30 years, should we still have this same sense of optimism that Jim Cullen had back on that aircraft carrier in the early 1960s? What do you think?

Well, we have a study going back 1920. Every single year, there was a reason not to invest. World War II, World War I, the Great Depression. There's always a reason not to get started. And the key thing is to get started because on that 5-year time horizon, you're going to get bailed out.

In other words, if the stock market does sell off again soon, it won't matter much if you're investing for the long run. Thank you, Steve, Jim, and Meta, and thank all of you for listening. Jack Howe is the host of this podcast. I'm the producer. Subscribe, tell your friends, rate us, review us. If you have a question you want answered on the podcast, record it on your voice memo app and email it to jack.howe@barons.com. That's H-O-U-G-H. See you next week.

Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you. Morningstar, where data speaks.