May 25, 2022
The Froth is Coming Off
Tim Urbanowicz, CFA
Head of Research & Investment Strategy
Innovator Capital Management
2022 has been a brutal year for risk assets. The Fed’s move towards more restrictive policy has sent speculative parts of the market into an all-out tailspin. Profitless technology stocks are off ~70% from their 2021 highs, SPACs are off 50%, Bitcoin is off 68%, and the retail darling, ARK Innovation ETF is off an additional 40% from Cathie Wood’s “bargain basement” call in February. No doubt a shift in sentiment from the “stocks only go up” mentality of 2020 and 2021.
A Big Move, But What’s Priced In?
We recently surveyed over 200 financial advisors to see if they believe the Fed can pull off a soft landing and steer the economy away from a recession. 77% of respondents didn’t think so. Interestingly, while this sentiment has clearly been expressed in speculative pockets of the market (i.e., profitless tech), it hasn’t yet trickled through to the broad equity market. Even though the S&P 500 is off 17% from its high, the repricing and new valuation still leaves the S&P 500 nowhere near past recessionary levels.
The table below outlines the previous ten U.S. recessions, and the valuation (price to earnings) of the S&P 500 at the onset of the recession. On average, the current valuation of the S&P 500 is 22% above past recessionary levels. Outside of the COVID induced recession and the one in 2001, the S&P is still trading meaningfully above where any recession prior has begun.
Source: Bloomberg LP
Source: Bloomberg LP, data from 12/1/1990 – 4/1/2022
Could this be a Buying Opportunity?
Admittingly, while valuations may be elevated right now, the 2022 repricing may be the “better entry point” so many have been waiting for if the Fed can thwart a recession. After all, we have not seen valuations this low since Q1 2020.
This is no doubt a gamble (with poor odds in my opinion) and dip buyers have been punished thus far this year. If the Fed does pull it off, it would be the first time they were able to avoid a recession with inflation this high. And let’s not forget the balance sheet runoff that will be pursued in tandem.
Hedge a Recession & Recovery All in One
With all the risk and increased volatility, I believe this is one of the reasons Buffer ETF assets have grown. This year alone, Innovator’s Buffer ETFs have seen ~$1.7B of new net inflows, a 25% boost in shares outstanding in just 4.5 months. Also notable, 20% of the flows have gone into the 30% Buffers, highlighting investors’ desire for increased buffers against loss. I believe another reason for the uptick is the funds’ caps; with the current market conditions and high volatility, we are seeing some of the highest caps in history.
The Innovator U.S. Equity Ultra Buffer ETF – May (UMAY) seeks a 30% buffer against losses over a 12-month outcome period, and reset with a 11.59% cap. With buffers of 9%, 15%, and 30% over 12-months, and a 20% Buffer each quarter to choose from, I believe these ETFs may provide an attractive option to hedge recession risk while simultaneously providing a call option on a soft landing.
The price to earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its earnings per share.
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