Volatility started to pick up a bit this week in both directions. However, volume statistics are declining due to a slowdown in retail activity. Our market may finally be changing. Value and growth stocks have been held hostage to moves in interest rates. Yields went up, tech went down and value stocks rose. This week is different. Yields went down the past 3 days, but most tech stocks are down. Bitcoin is down for six straight days.
It’s possible some of this is just due to a rise in Covid cases and profit taking. Michigan cases are spiking due to the B variant. Locally, Pennsylvania and New Jersey cases are back up double digits. Europe, India and South America are still a mess. We will get to the end of this, but this is a clear reminder it won’t be easy. Markets rebounded sharply after a morning swoon yesterday, following another 2% drop in the Nasdaq on Wednesday, only to finish fractionally higher.
Frothiness in unprofitable, but high growth companies is also dissipating quickly. Retail favorites have seen massive declines in just a few short weeks: Tesla, Snap#, Shopify, Square, Spotify, Zoom Video and Moderna all dropped 30% from recent highs. This isn’t just due to higher interest rates either. Valuations got out of hand on the upside and reversions are a normal course of business. Nothing goes straight up forever. The average retail investor is finally facing a period where stocks don’t provide instant rewards. Volumes decline and investors lick their wounds in preparation for the next leg. We’ve all seen this cycle numerous times, whether you started investing in the 50’s or the past decade. History doesn’t repeat but it often rhymes. This consolidation is necessary before another leg up.
What happens from here is the next question for investors. Most of the above names are world class companies and built to last, but not all. Critical due diligence is required to break up the list of future winners and losers. Some are getting back to fair value levels and can be bought over the coming weeks. Who knows where the final bottom is, but some are approaching investable price levels while others may never see the old highs again.
As you may know, I enjoy lists. Let’s look at some of the bearish and bullish themes as we approach the end of the first quarter. On the bearish side:
• Over time, every added dollar in stimulus has a decreasing effect. A trillion dollars in stimulus 25 years ago may have boosted GDP by 10%. Today that effect is only 3% at best. Further, interest payments on that debt are only rising from here. Although initially this brings a boost in spending and inflation, this is very deflationary over time.
• Current inflation and rising rates will wreak havoc on smaller companies that don’t have diversified supply chains or pricing power. General Mills reported a 5% rise in grain and other input costs. This will impact profit margins. The big companies can offset it, the little guys cannot.
• The number of consumers that can refinance are declining. Last year, 30-year mortgages were being refinanced below 2.5%. Today that rate is back over 3.2% and heading higher. Drive around any suburb in the U.S. and you’re going to see pools, decks and patios being installed. A lot of this came from refinancing which creates a onetime boost in spending.
• SPAC’s are still raising money at an unsustainable rate. This form of IPO capital raising totaled $43B from 2013 – 2018. Then they raised $83B last year. We have already seen $98B in deals in 2021. Some SPAC originators have 6+ new funds alone. This capital has to come from somewhere, usually via selling equities.
• Small caps have dropped 9% in 2 weeks. That index, emerging markets, developed markets and the Nasdaq are now trading below their 50-day moving averages. When short-term momentum is lost, downside targets come into play towards the 200-day moving average. Those price levels are another 10% lower.
• Global manufacturing delivery times are worsening. In fact, they are almost as bad as last March when countries were shut down. A stuck ship in the Suez Canal won’t help matters either. Some of this will lead to lost sales.
• It is said that “smart money” trades during the final hour of the day. Stocks have been dropping precipitously during this time. Since 1997, there has not been a worse 3-month tally. What that means is institutional money is leaving the market. Institutions have more information than many and are worth our attention.
• With the recent collapse in bond prices, pensions and target date funds are forced to reallocate prior to quarter end. Economists estimate $200+B in equities will be sold and moved to fixed income in order to get back to desired asset allocation levels. Historically, this is one of the highest numbers on record. Some of this may have already happened this week.
That was a bit scary, but we’ll end the letter (and start the weekend) with the bullish case:
• Nothing works more than “don’t fight the Fed.” Not only are they helping by keeping short rates anchored at zero, but they intend to let things get hot before pulling the punch bowl. They are on the side of investors.
• Rates have risen, but are still negative across the globe. It is time to borrow and take chances for big and small corporations before loans get expensive. Capex is growing.
• Valuations are improving. Earnings expectations for 2021 are only going up. By the end of the year, we could see a $200 EPS figure for the S&P. Granted, a 19 P/E is still above normal, but interest rates are well below the norm as well. It is a fair metric. Assuming growth keeps above trend in 2022, we could be looking at a cheap market in time.
• FANGMAN stocks have lagged for nine months now. However, they are getting very attractive in some cases. When go-go growth, 100+ P/E stocks got hammered, they took everything down with it. Some of the mega cap conglomerates are back to sub 25 P/E’s but still expect earnings to grow by double digits for years to come. Not bad at all.
• Money supply, on a global scale is up a staggering $13T over the past year. That’s 15% on average. This money will make its way into economies. Maybe not on a 1 for 1 basis, but enough to move the growth needle.
• Although Covid cases took a turn for the worse this week, the trend is our friend. Whether it is two months or six, vaccines and herd immunity are coming. We will get back together in person over time. Pair that with ample checking accounts and consumers are ready to spend. GDP in 2021 is certain to be the best in a long, long time.
• Stimulus checks, job openings, record housing prices and stock market levels within spitting distance of all-time highs, all point to rising net worth. When we feel our personal wealth is rising, we spend more. GDP is still dominated by consumer spending. It is coming and it will be strong.
The end result is a near-term pocket of consolidation that will take down those that were way overpriced to begin with. It will also create an opportunity to separate the wheat from the chaff. Identifying consistent leaders that are declining to opportunistic entry levels is the next step for investors.
It is a busy birth date with musical stars Diana Ross, Steven Tyler and Kenny Chesney turning 77, 73 and 53 respectively. Actors James Caan, Martin Short, Jennifer Grey, Leslie Mann and Keira Knightley are now 81, 71, 61, 49 and 36. Speaker of the House, Nancy Pelosi is also turning 81 today.
James Vogt, 610-260-2214