Here’s why one big bad bear is suggesting the stock market could crash by 50%

Where interest rates go, so do stock markets.

Overnight, the US Federal Reserve indicated it was prepared to keep lifting interest rates to tame inflation but was wary of overcooking it, potentially sending the US economy into recession.

“… there are signs some officials are getting a little nervous that they could end up going too hard and may need to reverse course eventually,” said James Knightley, chief international economist at ING, in a note quoted on Marketwatch.

Initially, the markets liked what they were seeing, looking ahead to the days when interest rates would be cut.

But then a dose of reality hit as traders remembered, before then, it will still take some super-sized increases in interest rates to tame inflation running at 8.5%.

The Dow Jones Industrial Average Index (DJX: .DJI) snapped a five-day winning streak, falling 170 points, or 0.5%. The NASDAQ-100 Index (NASDAQ: NDX) fell 164 points or 1.3% as traders took profits in growth stocks.

Naturally, the S&P/ASX 200 Index (ASX: XJO) followed the lead of US markets and was lower in early afternoon Thursday trade as coal and oil stocks rose, offsetting falls in tech and gold stocks. Never a straight line…

Has the market bottomed?

The big bad bears at Bank of America think markets haven’t bottomed, despite the Dow having jumped 17% higher since its June low and the ASX 200 having gained a more modest 10%.

“Only 30% of our bull market signposts [things that happen before a market bottom] have been triggered versus 80% or more in prior market bottoms,” the bank’s equity and quant strategist, Savita Subramanian, said in the AFR.

Based on his ‘Rule of 20’, the price-to-earnings (P/E) ratio should be 11 and not 20. 

At a time when earnings are falling and therefore P/E ratios are rising, the market could fall 50% from here, according to Bank of America’s rule.

A fall of that magnitude would entail some capitulation. I’ll happily take the other side of that bet and say markets won’t fall 50%.

A glass half-full perspective

I’m always a glass-half-full person when it comes to the stock market. My ‘Rule of One’ (the one being me) is if markets rise, I’m happy as my existing portfolio gains. If markets fall, I’m happy too as it allows me to buy some companies on the cheap.

Which reminds me of a quote from billionaire investor Charlie Munger…

“If you’re going to be in this game for the long pull, which is the way to do it, you better be able to handle a 50% decline without fussing too much about it.”

Take that, Bank of America!

Cheap ASX shares ahoy

Finding cheap stocks amongst the ASX 200 is no easy feat. 

Commonwealth Bank of Australia (ASX: CBA) on a P/E of 18? No thanks.

CSL Limited (ASX: CSL) on a P/E of 40? No thanks.

Mega-cap mining stocks like BHP Group (ASX:BHP) and Fortescue Metals Group (ASX:FMG) are cheap and are trading on bumper, fully-franked dividend yields, but this is the top of the cycle, historically not a great time to be buying mining companies.

That said, the Fortescue share price has hardly set the world on fire over the past 12 months, down 11%, lagging the return of the ASX 200. The market might have already priced “the top of the cycle” into the stock. 

On a trailing basis, Fortescue shares trade on a fully-franked dividend yield of more than 15%. That yield will come down once the iron ore giant reports full-year results, including its final dividend, on Monday, 29 August but is likely to still be at elevated levels.

A play on Fortescue is a play on the iron ore price, which is a play on China, which is also partly a play on the global economy. If only stock picking was easy…

Where to turn

When looking for cheap stocks, I prefer the small end of the market. Not only can you find companies that are growing quickly, but they are also often overlooked by fund managers because they are either too small to move the dial and/or too illiquid to buy and sell. All of which means small and microcap companies can trade at dirt cheap prices.

As I mentioned yesterday, one of my microcap holdings – MSL Solutions (ASX: MSL) – was announcing results today. The leading SaaS technology provider to the sports, leisure, and hospitality sectors reported bumper revenue growth of 37% and a 70% increase in earnings before interest, tax, depreciation, and amortisation (EBITDA), both nicely above expectations. 

Frustratingly for shareholders and management, the MSL Solutions share price has hardly budged in Thursday trade, up just half a cent or 3% to 17 cents, still a long way from its 28 cent 52-week high.

Microcap investing can be a game of patience. And one that requires diversification, if nothing more than to relieve the boredom of waiting for the market to recognise what you think are results worthy of reward.

To stop me from getting bored, I’ve put plenty more irons in the fire, including one microcap that’s trading on just 2.5 times its recently upgraded EBITDA forecast. I’m hoping its results will be greeted by more than a passing yawn. 

The post Here’s why one big bad bear is suggesting the stock market could crash by 50% appeared first on The Motley Fool Australia.

(function() {
function setButtonColorDefaults(param, property, defaultValue) {
if( !param || !param.includes(‘#’)) {
var button = document.getElementsByClassName(“pitch-snippet”)[0].getElementsByClassName(“pitch-button”)[0];
button.style[property] = defaultValue;
}
}

setButtonColorDefaults(“#0095C8”, ‘background’, ‘#5FA85D’);
setButtonColorDefaults(“#0095C8”, ‘border-color’, ‘#43A24A’);
setButtonColorDefaults(“#fff”, ‘color’, ‘#fff’);
})()

More reading

• An ASX 200 market darling in the past, but don’t expect fireworks from the CSL share price going forward

Motley Fool contributor Bruce Jackson has positions in MSL Solutions Limited. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has positions in and has recommended CSL Ltd. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

from The Motley Fool Australia https://ift.tt/UzXbWSy