Jack Meskunas, Oppenheimer & Co
10 November 2022ArticleAnalysis

Are we there yet? Looking for a market bottom and the ‘all-clear signal’

The year 2022 will undoubtedly go down in history as one of the most tumultuous years in history—certainly recent history. While this is not an all-inclusive list, some of the events we have witnessed have been (in no particular order) the death of the longest-reigning monarch, the shortest tenure of a British PM, a war in Ukraine that has brought credible threats of nuclear war, the leader of China stating that they must “unify” Taiwan into mainland China (a territory never once in history ruled by Communist China), COVID-19 morphing from “pandemic” to “endemic”, major global currencies such as the pound, yen, and euro depreciating approximately 20 percent in a year versus the dollar, the sabotage of the largest pipeline from Russia to the EU, gas and oil prices quadrupling and pending shortages everywhere, $10 trillion of “stimulus spending” approved by the US government that has resulted in inflation at a 40-year high, the Fed raising rates at a pace faster than ever in history and, oh yeah: the meltdown of global stock and bond markets—with the US markets posting their worst start of the year since 1931!

With all this going on, captive insurance companies (and all investors for that matter) are looking for signs that the market has “bottomed”, that the yields on bonds have peaked, and that some sort of “all-clear” signal can be discerned so that we all know it is safe to go back into the markets.

I offer the following set of numbers to put what we are seeing into perspective:


  • 51: For over 51 years of market returns (going back to 1971) there have been
  • 30: Thirty times that the market has pulled back (gone down) over 10 percent during the year, but
  • 19: In 19 of the 30 years the market ended up “in the black” (positive) for the year, meaning
  • 11: In 11 of the 30 years the market had calendar-year declines, but keep in mind
  • 8: In eight of the 11 years the markets were down, they were up the following year, meaning
  • 3: That in only three of the last 51 years has there been two years in a row of negative returns—or 5.9 percent of the time.

I doubt that 2022 will end “in the black” meaning that—statistically—there is a less than 6 percent chance that 2023 will also be a year of losses in the markets. I like to say that while few things are certain in the investment business, there is one “event” that has occurred 100 percent of the time with regard to “bear” markets (markets that are down over 20 percent from a prior peak). That certainty is that bear markets always end the same way: they end.

Inflation is good?

Inflation is never considered a good thing, but let’s put it in perspective. The Fed targets an inflation rate of 2 percent a year—if inflation is “bad” then why doesn’t the Fed target a rate of 0 percent inflation?

Inflation—defined as rising prices—is the very engine of growth in the stock market. How does this work? Think about the cost of a can of Coca-Cola. This is a product that hasn’t changed in 136 years aside from taking the cocaine out of the formula in 1905, and New Coke. In 1950 a Coke cost 5 cents.

By 1960 it was 10 cents. Today a single can of Coke is about a dollar or so. In the early 1960s, one share of Coca-Cola stock was (adjusted for splits, but not dividends) was about 50 cents. Today that share is over $55, up 110 times. It is literally the main reason that Berkshire Hathaway has become the company it is—it is the largest shareholder of Coca-Cola stock, with over 400 million shares worth over $22 billion.

As companies are able to raise prices (cause inflation, or react to inflation), and if they are well managed and can keep their costs rising more slowly than their revenues, they become more profitable. As they become more profitable their share prices appreciate in the long run. All other things being equal, it is the sheer existence of inflation that causes stock prices to rise over time.

What is damaging to businesses, consumers, and markets is high inflation, or “stagflation”. High inflation may be relative, but we can all “feel” that inflation where it is now—hovering around 10 percent—is too high. Inflation as it exists in Europe—around 15 percent, or in Turkey around 83 percent—is unsustainable if an economy is to thrive. Stagflation, a “gift” from the Carter administration, is high inflation coupled with high unemployment. We are not at this time anywhere near this, as the US economy has around 3.5 percent unemployment and almost two open jobs for each unemployed person.

So what “weapons” does the Fed have to fight inflation? We are seeing them put to use now. They can jawbone (talk) about what the market should be doing. They can change interest rates of the “discount rate” or overnight rate. They can cause quantitative tightening or easing. Right now, they are jawboning, raising rates, and tightening all at the same time. It has market watchers and participants running for the hills!

The Fed’s actions and the above-mentioned events have left devastation in the markets. They have reduced the value of captive insurance portfolios that had historically seen drops in stock values coupled and offset by increases in values of their fixed income portfolios due to the age-old inverse correlation between the performance of stocks and bonds.

That relationship has broken in 2022 with every asset class declining in value this year. Through the end of Q3 the stock market (defined in this instance as the S&P 500) was down about 25 percent, the average stock was down over 50 percent, and the bond market had declines of 8 to 20 percent, depending exactly on what types of bonds you owned.

Bearish is bullish

The last time investors were this bearish was in 2009. To put a finer point on it, peak bearishness (or trough bullishness) occurred on March 12, 2009. This was four days after the market bottom on March 9, 2009. The market had declined over 50 percent to March 9—it rallied 12 percent by March 12 and on that day only 8 percent of investors were “bullish”. The rally continued from that point and ended 2009 up +65 percent from the market low!

Where are we now? Table 1 created on September 24, 2022 shows that we “achieved” trough bullishness of 8 percent in September 2022. If we look historically what market returns look like coming off such bearishness, on average four, 13, 26 and 52 weeks after such a bearish signal the market has been up 3.4 percent, 5.6 percent, 9.2 percent and 16.1 percent respectively. Bearishness is bullishness in this case.

Table 1: S&P 500 average forward returns

Table created on September 24, 2022; courtesy Ari Wald, CFA CMT Technical Analysis Oppenheimer & Co

Implications for captives

As always, captives need to constantly evaluate what they are doing with their assets, and if the strategy makes sense then they need to stay the course. Of critical importance is maintaining the necessary liquidity to pay claims on a timely basis without having to liquidate stocks or bonds at potentially unfavourable times.

In the last decade or so, cash has had zero yield. Now with short duration bonds yielding around 4 percent, there is a great opportunity for captives to take zero yield cash assets and reallocate to ultra-short or low duration strategies and capture yield and liquidity.

And for those who still want to have the “active vs passive” debate on asset management? Let 2022 be the poster child for active beating passive hands down, in both stocks and bonds. While I have always felt “passive” bond investments (mutual funds, exchange-traded funds [ETFs]) have been a terrible idea, 2022 has made everyone painfully aware that bond funds and ETFs in a rising interest rate environment have been a disaster for captives and should continue to be avoided.

Calling the all-clear signal

Unfortunately no-one calls “all clear” to get back in the markets, but we are seeing many signs that we may be there. I personally doubted we would see S&P below about 3600, and a 50 percent retracement from prior highs would take the S&P to 3505. We briefly touched that level (intra-day) and jumped right back up in October.

There are some significant events still to come in 2022: US mid-term elections, Ukraine, UK, and China could all render positive or negative surprises, but one thing is certain—bear markets always end the same way: they end. The only way to profit from the end of a bear market is to put money and new premiums to work in a consistent basis for your captive, keep averaging your costs and utilising great managers and time—and inflation—will be on your side.

Past performance is not indicative of future results. All investments involve risk. An investment in this strategy involves a significant degree of risk, including, without limitation, the risk of loss and/or volatile performance. All opinions expressed are current as of the date of this letter and are subject to change. Forward Looking Statements: Any projections, forecasts and estimates (including, without limitation, any target rates of return) contained in this overview are necessarily speculative in nature and are based on certain assumptions. It can be expected that some or all of such assumptions will not materialize or will vary significantly from actual results. Accordingly, these projections are only an estimate. Actual results will differ and may vary substantially from the results shown. The risks associated with investing in fixed income include risks related to interest rate movements as the price of these securities will decrease as interest rates rise (interest rate risk and reinvestment risk), the risk of credit quality deterioration which is an issuer will not be able to make principal and interest payments on time (credit or default risk), and liquidity risk (the risk of not being able to buy or sell investments quickly for a price that is close to the true underlying value of the asset). This article is not and is under no circumstances to be construed as an offer to sell or buy any securities. The information set forth herein has been derived from sources believed to be reliable and does not purport to be a complete analysis of market segments discussed. Opinions expressed herein are subject to change without notice. Additional information is available upon request. Oppenheimer & Co. Inc., nor any of its employees or affiliates, does not provide legal or tax advice.

Jack Meskunas is a financial advisor with Oppenheimer & Co. He can be contacted at: jack.meskunas@opco.com