Stocks will fall 78%, investors say, with a 40% return

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  • Last year, Kevin Smith of Crescat Capital predicted a significant correction in the stock market.
  • This year, Smith’s global macro hedge fund returned 40% to investors through April 30.
  • He expects further difficulties for stock market investors due to a stagflationary environment.

Some of the biggest names in investing believe further declines are on the horizon for the US stock market this year, although it has already fallen in double digits.

Morgan Stanley equity chief Mike Wilson, who predicted the last three stock market crashes, warned that stocks could fall another 14% by the end of the second quarter.

Renowned economist David Rosenberg said the S&P 500 could fall another 17% to 3,300 points.

A macro hedge fund chief, however, makes a bolder call.

Kevin Smith, founder and chief investment officer of Crescat Capital, said stock prices could potentially fall another 78% to settle at the low multiples of the last stagflationary era in a May 29 note.

“In any case, the market seems to be in a state of illusion today, with the average participant still buying the drop in overvalued tech, crypto and fixed income assets, hoping for a return to those fads, while underestimating inflation risk continues high in precious, scarce and tangible resources,” Smith said in the note.

Investors might think Smith is the one delirious with this call, but he’s been right so far.

In September, he wrote that he expected a 42% correction in the S&P 500 to occur within a year as investors positioned themselves for perfection in equities as inflation kicked in. to resume. In December, he warned of an impending sell-off in the S&P 500.

Since the start of this year, the S&P 500 is down 13%, while the Nasdaq has fallen 22%. Smith’s funds, on the other hand, surged: his macro hedge fund returned 40% through April 30, while his long/short hedge fund returned 19%.

How low can stocks fall?

Smith’s thesis on another


bear market

revolves around the idea of ​​inflation


recession

.

“The index is down 15% from its all-time highs but still trading at 187% of GDP,” Smith said in the note. “During the comparable stagflations of the early 1970s and 1980s, the associated bear markets did not end until total market capitalization traded at an average of 35% of GDP.”

Previous stagflationary eras have brought low market multiples, but the Nasdaq 100 index still trades at high valuation multiples, Smith said.

“If we look at comparable bear market regimes, there is still substantial downside risk for this large-cap tech index,” Smith said.

“Conservatively, if we assume stable sales and earnings over the next two years in a likely recession, there is another 50% to 69% downside risk,” he added. “Of course, the market can bottom out at higher valuations, but that’s wide-eyed risk based on math and history.”

The


Federal Reserve

is raising interest rates to curb soaring inflation, but Smith believes prices will remain high due to structural commodity supply shortages.

“These industries have long lead times, so production cannot be scaled up without years of increased investment,” Smith said. “As a result, the world now faces a cliff in commodity supply and a likely parabolic rise in energy and food prices… In our view, this will lead to crippling stagflation in the medium term, and this is just the beginning.”

Rising interest rates could even make the supply problem worse because it raises the cost of capital to invest in the production of new commodities, Smith said.

“There is a much greater risk based on our work that inflation will remain elevated, and the Fed will end up having to hike more and for longer than currently expected, as in all past tightening cycles,” Smith said. “Alternatively, there is the risk that the stock market correction will continue within the existing planned increases and that the Fed will panic and end its hike cycle for the first time with real rates still in negative territory.”

Positioning for fall

It may seem like a nightmarish environment for investors, but Smith still sees “high appreciation” investment opportunities in the market with commodity exploration and production stocks.

Investment firm GMO, which was co-founded by legendary investor Jeremy Grantham, recently issued a similar call by turning bullish on resource stocks, which it points to as trading at extremely attractive levels.

“Along with energy, base metals, agriculture and forestry products, precious metal miners are where some of the deepest potential for value and appreciation in the market currently lies,” he said. said Smith.

According to the note, Crescat Capital is currently short in a variety of industries and individual stocks, while positioned long in a variety of commodity-related explorers and producers.

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