- Last year, Crescat Capital’s Kevin Smith 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 pain for stock market investors due to a stagflationary environment.
Some of the biggest names in investing think further declines are on the horizon for the US stock market this year despite it already plummeting by double digits.
Morgan Stanley’s equity chief Mike Wilson, who predicted the last three market crashes, warned that stocks could fall another 14% by the end of the second quarter.
The famed economist David Rosenberg said the S&P 500 could fall an additional 17% to 3,300 points.
One macro hedge fund chief is making a bolder call, however.
Kevin Smith, the 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 all cases, the market seems to be in state of delusion today with the average participant still buying the dip in overvalued tech, crypto, and fixed income assets, hoping for a return to those manias, while underestimating the risk of continued high inflation in valuable, scarce, tangible resources,” said Smith in the note.
Investors might think Smith is the one who’s delusional with this call, but he’s been right so far.
In September, he wrote about his expectation for a 42% correction in the S&P 500 to play out within a year as investors positioned for perfection in equities, while inflation started to pick up. By December he was warning of an imminent sell-off in the S&P 500.
Since the start of this year, the S&P 500 has declined by 13%, while the Nasdaq’s dropped by 22%. Smith’s funds on the other hand have surged: his macro hedge fund returned 40% through April 30 while his long/short hedge fund returned 19%.
How far can stocks fall?
Smith’s thesis on a further
centers on the idea of an inflationary
“The index is off 15% from its all-time highs but still trading at 187% of GDP,” said Smith in the note. “During comparable stagflations of the early 1970s and 1980s, the associated equity bear markets did not end until the total stock market capitalization traded down to an average of 35% of GDP.”
Previous stagflationary eras brought low stock multiples but the Nasdaq 100 index is still trading at lofty 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 flat sales and earnings over the next one to two years during a probable recession, there is another 50% to 69% downside risk,” he added. “Sure, the market may bottom at higher valuations, but this is the eyes-wide-open risk based on math and history.”
is in the process of hiking interest rates to curb surging inflation, but Smith believes prices will still remain elevated due to structural commodity supply shortages.
“These industries have long lead times, so output cannot be ramped up without years of increased investment,” Smith said. “As a result, the world now faces a commodity supply cliff and likely parabolic increase in energy and food prices … In our view, it will lead to crippling stagflation over the medium term, and it is only the beginning.”
The rise in interest rates could even make the supply issue worse as it makes the cost of capital for investment in new commodity production higher, Smith said.
“There is a much bigger risk based on our work that inflation stays elevated, and the Fed ends up having to hike more and for longer than is currently priced in, as in all past tightening cycles,” Smith said. “Alternatively, there is the risk that the stock market correction continues under the existing planned increases and the Fed panics and ends its hiking cycle for the first time with real rates still in negative territory.”
Positioning for the fall
This might sound like a nightmare environment for investors, but Smith still sees “high appreciation” investment opportunities in the market with commodity exploration and production equities.
Investment firm GMO, which was co-founded by legendary investor Jeremy Grantham, recently made a similar call turning bullish on resource equities, which they highlight as trading at extremely attractive levels.
“Along with energy, base metals, agriculture, and forest products, precious metals miners are where some of the deepest value and appreciation potential lies in the market today,” Smith said.
According to the note, Crescat Capital is currently short a variety of industries and individual equities, while positioned long in a variety of commodity-related explorers and producers.