The current market is getting somewhat ridiculous, with all but three stocks in the entire Nasdaq losing value on Friday, and literally the whole DOW going down... This is especially surprising given that the companies taking a beating include safe ones in the commodities sector (with current cash flows and making real things, with excellent pricing power), Proctor & Gamble, and the Healthcare sector. Not only that, but some high-growth stocks held up well, with Upstart (one of our favourites) dropping less than a half a percent. That said, I think it will be informative for you guys to understand what is going on, and get a better sense of the market we're in, and generally how to think about navigating it!
Now to preface everything, it’s important to realize that timing the market is a losing game. In a growing economy, investing at almost any time is a good investment over the long run - this is especially true after the market takes a big haircut like recently. Regardless of if you had bought at the top of the 2008 or 2020 crashes, or virtually any crash in history, you would have still made money if you had held on for 3 years or 3 months (in 2020’s case). Essentially, if you believe in a company’s growth trajectory, and the price you are getting, then buying it is almost never a bad decision only because of timing. That said, if after careful analysis you think the macro environment might cause a recession, waiting till closer to the bottom could be a good idea.
All that said, let’s get into what is currently going on. The current bear market is the product of two main factors: the Fed, and Ukraine. Essentially, ever since the lockdowns of 2020, the financial system has been relying on ever easier monetary policy - pushing up real estate, investments… Unfortunately though, this, combined with unprecedented government stimulus and supply shortages, has created the worst inflation crisis in 50 years. Inflation, while good in moderation, evaporates savings and wildly pushes up cost of living. The only real solution to this is cutting back on fiscal & monetary stimulus. This involves raising interest rates from the Fed, as well as unloading its balance sheet to cool off markets. This reality means that as investors, you are in some ways now fighting against the Fed (never a good choice, since they can print infinite money). The previously mentioned supply shocks were also compounded by the invasion of Ukraine, which pushed up the cost of gas (Russian) and food (Ukrainian fertilizer), leading to even more inflation, and leading to an even harsher Fed. We can see this taking place now with 6 rate hikes expected for 2022, some of those likely being 50 basis points, and some fed chairs even mentioning 75 basis points per hike.
When interest rates are high, borrowing costs for companies become higher, and this means less expansion. For real estate, it means that normal people can no longer afford their variable mortgages and it means new buyers are priced out. Meanwhile, the cost of inflation is forcing consumers to cut back on spending despite record job & wage growth. All of those things combined can easily lead to a recession, meaning a bad economy, meaning worse earnings… On top of all this, higher interest rates in general mean that flexibility in terms of future earnings comes way down. Higher costs of borrowing, means that the yearly carrying cost of an asset increases. This is especially important for high growth stocks, since their value (as we've seen before) is predicated mostly upon the future value of their earnings, based around expectations of future growth compounded. However, with a higher annual cost, the required rate of return must get higher as well. As such, the calculations associated with valuing these companies (mostly tech stocks) become more complicated and harsher. This reality is why the Nasdaq is multiplying the S&P’s losses by a wide margin. We can see this idea of worse earnings from consumer spending concerns showing up in recent earnings. Netflix cratered 37% on a report that it lost subscribers, and a forecast for even higher losses next quarter, citing competition & password sharing - but sparking fears consumers just had to cut back on spending. JpMorgan also compounded these fears by essentially forecasting a recession on the earnings call. Meanwhile, Gap just cratered 18% after concerns in its Old Navy business - yet another consumer spending company saying that demand was weak.
All in all, from an investor’s perspective it is super easy to get scared even when ignoring the possibility of a war that we have ignored so far. However, it is important not to forget that the job market has never been stronger and as supply chains cool off, so too will prices, and the economy will likely get back on track. These two different worlds give two completely separate signals to investors. The first is that if you have a real fundamental reason to buy a stock (at a cheap price), and the macro analysis (like what we just did above) doesn’t affect that - then you should probably go for it! In the meantime, you should also consider the fact that a sinking tide sinks all ships. That means that there are probably a lot of companies that are completely unrelated to the macro headwinds, and are being sold-off on purely speculation. These types of stocks could be excellent purchases. At the same time, it also goes the other way, in that speculative investments (like tech stocks) become a lot more dangerous and so building in higher margins of safety and lowering expectations in your models is probably in order. At the end of the day, as long as you are practicing caution, and making sure to stick to the fundamentals, you should be more than fine over the long term!
By: Mateo Gjinali
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