When you are in the midst of a bear market, all the news is bad. You are usually either in or about to be in a recession. Analysts that kept telling you to buy stocks at 50% higher prices, now tell you to sell the same stocks despite them being dramatically cheaper. Economic data gets worse and charlatan newsletter salesmen and market pundits profit from selling fear. Of course in financial markets, anything can happen, but history has shown us that these are the types of environment, which foster some of the best buying opportunities. Stocks can turn higher well before the actual economy does, just like they started selling off roughly 9 months ago, well before any actual recession arrived. Where market participants go wrong is when they try to time the market, locking in losses, and missing out on the robust gains, much of which comes right off the bottom. You can see 20% moves higher in just a few weeks and it becomes difficult to get good performance when you miss out on those big moves, which is why it makes sense to stay invested. Fortunately, we are able to use tools such as selling cash-secured puts at large discounts to current prices, which can provide ample protection, unlike when you are 100% long stocks, as most index or mutual funds are. This should make it far easier to recover and benefit from that next bull market that emerges like a phoenix from the current conflagration.
According to value firm Pzena’s analysis, on average 1 year from the start of a recession, the market has been up 3%, while value stocks have been up 5%. 5 years from the start of a recession, the market has been up 53% on average, versus 91% for value. I think it is very possible we have just entered into a technical recession, but even if that is the case, consumers and businesses are in far better shape than they have been in going into any other recession in our lifetimes. Unemployment is still very low and while the numbers will get worse, this shouldn’t be anything close to what we saw in 2020, where the unemployment rate jumped to 15% within 3 months. The banking system, loan underwriting, and the housing market are all in far better condition than they were during the Great Recession. Banks have double the capital and liquidity that they had then as an example. Pzena talks about trying to time the market in an insightful quote”
“The two most recent recessions highlight the difficulty in timing re-entry points. Assume an investor was lucky enough to have lowered their equity allocation prior to the Global Financial Crisis. How comfortable would they have been reversing course at the depths of despair in March 2009, before there was any clarity on how the crisis would be resolved? From that point, the market rose 51% through the remainder of 2009, closing the year up 23% in a period where the viability of the entire financial system seemed in doubt.
Even more recently, suppose in late 2019 an investor reduced their equity allocation, correctly predicting the world would essentially lock down due to Covid and the markets would sell off sharply. Would they have the fortitude and foresight to turn bullish when stocks dropped by a third in about a month? After all, Covid was just declared a global pandemic and the lockdowns had no end in sight. Two months later the market was 40% higher, and by year-end it was 65% above its lows by year-end.”
It is in bear markets when you can buy assets at the most attractive prices. One stock that we have done quite a bit with is Pinterest, where we’ve sold puts at $15 and below, collecting high-double digit annualized premiums in many cases. The stock is down 50% on the year, which created the opportunity for us to initiate positions on this attractive technology business at prices that we believe to be well below intrinsic value. On Thursday, it was revealed that Elliott Management Corp. (one of the elite investment funds in the industry) has built a 9% stake in the company, resulting in the stock climbing by nearly 25% after hours. I expect to see many more of these value uncovering market transactions on our positions, as the stocks are ridiculously priced even if we have a pretty severe recession.
On Thursday JP Morgan (JPM) reported earnings, where they made another nearly $9 billion dollars, despite horrendous capital markets where equity and debt underwriting was basically nonexistent. The stock is now available for just over 8x forward earnings. The inverse of P/E gives you the earnings yield, which is what that business would pay you if you owned 100% of it, which is 12.5% for JPM currently. Would you want to own a business that provides a 12.5% cash on cash return in your first year, while being the most dominant bank in the world, with the ability go grow earnings by 5-10% per annum moving forward? We are doing that today in the stock market and JPM is probably the lowest earnings yield of all the banks. Here is my latest research report on the stock completed today after earnings: Tim’s JPM Research Report
Citigroup is more of a 20-25% earnings yield, and ALLY is as well. It’s not fun going through a bear market, but they are inevitable and we plan for them ahead of time, which is why we use the strategy we use. This is when you plug your nose and invest, planting seeds, which will provide a bountiful harvest once the storm subsides. As our options expire, time and volatility will go to zero and our upside potential will be as high as it has ever been on the remaining positions. There really aren’t any large positions I’m concerned with whatsoever, even if we do indeed go into a recession, so I think we are in great shape. I’ll leave it there for now, but I’ll be very active writing as earnings season is now starting in earnest.