August 2022 Mid-Month Update: Bear Market Rally?

The last two months have been a relief for most investors with exposure on the long side with a significant rally off the June 16th lows. The Nasdaq managed to notch gains of over 23% and the S&P 500 was not too far behind with gains of 17%. Merger arbitrage spreads that had widened significantly shrunk and 18 active deals closed in just the last four weeks. Beaten down tech stocks that had dropped anywhere from 60% to 95% from their peaks were the biggest beneficiaries of this rally. On June 15th, two days before this rally began, I wrote the following in our June 2022 Mid-Month Update discussing our bear market playbook,

When adding technology stocks like Twilio (TWLO) and Doximity (DOCS) to our model portfolio, we had indicated that we were concerned about market volatility and want to build those positions over time. I think the time has come to start adding to positions. This bear market is far from over but it is impossible to pick the tops or bottoms of markets. The bear market playbook I have set up includes three sections.

1. The first section consists of existing positions that look attractive and that I would like to add to in three separate trades or tranches, spread several months apart. The three trades could be based on time (one every three months) or the overall market dropping to specific levels (the S&P 500 down 25% from its prior peak for example). This requires reassessing all existing positions to make sure they appear to be sound investments going forward and not just picking the ones that have dropped the most in the portfolio. Existing positions in the model portfolio that I would not mind adding to include Healthcare Trust of America (HTA), First Horizon (FHN), Doximity (DOCS) and Twilio (TWLO).
2. The second section consists of companies in my watchlist that I classify as leaders. These are companies that lead their sectors or industries, are probably best suited to weather a storm and are on sale now. Some of the companies from my watchlist that I am keen on buying include Williams Sonoma (WSM), Alphabet (GOOG), Snowflake (SNOW), Costco (COST) and Microsoft (MSFT).
3. The third section consists of riskier companies that have been beaten down very badly, have leveraged balance sheets or are currently trading at cyclical peaks. The ones that survive within this group often generate significant gains coming out of a bear market. Companies from this group that are on my watchlist include Freshworks (FRSH), 1Life Healthcare (ONEM), Netflix (NFLX), SoFi Technologies (SOFI) as well as the spinoffs Warner Bros. Discovery (WBD) and Douglas Elliman (DOUG).

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