Happy Friday the 13th! The CPI and PPI reports did little to quell inflation fears. Although they helped make the case that inflation is peaking, the decline in prices was not enough. Fueled by rents, airline fares and a methodology change to vehicle pricing that took out a lot of the recent declines, both CPI and core readings were higher than expected. Markets responded in kind with the usual suspects, growth stocks, taking it on the chin Wednesday with some mixed follow-through yesterday for mega-cap darlings. Liquidity continues to be drained, causing unusual action in several pockets. When everyone is forced to sell (margin calls), you have no choice and must sell anything. Too many people rushing for the same exit creates a whirlwind of pressure, dropping prices for even the most well-run companies.
A case in point would be Apple, one of the best investments of this century. Chartists have been pointing towards the $150 support level as a critical holding point. Just one month ago, Apple stock was flat for the year, much better than just about every tech stock. In bear markets, which we are certainly in for tech stocks with the Nasdaq now 30% off recent highs, previous leaders are the last to fall. Fast forward just four weeks and Apple is now down more than the S&P 500. While technical analysis does not take into account fundamentals by any stretch, it is widely followed by Wall Street. Apple tested this $150 level on multiple occasions before succumbing to selling pressure late Wednesday afternoon, now it has quickly fallen to $142. Nothing fundamental has changed in two trading days. Whether it is because of margin calls or repositioning into safer areas, world class operators eventually get hit. Ditto for Tesla, which was also handily outperforming just a few weeks ago. Now the stock is down 31% year-to-date. While Apple has over $50B in cash on hand, has zero debt financing concerns, generates a ton of profit and trades at 21 times earnings, Tesla is in a much different situation with its 60 P/E and dependency on tax credits. Not all breakdowns are created equally.
While painful to watch on a daily basis, this action is good for long-term investors who focus on fundamentals and have some cash waiting. As noted, the best of the best are the last to fall during corrections like these. Excessive euphoria has already hit the low-quality companies. Look at the list of Meme Stock returns from last year’s high:
Bed Bath & Beyond -81%
Beyond Meat -87%
Virgin Galactic -91%
The “soldiers”, if you will, are the first to get whacked. They have little earnings power to support a tightening in liquidity, higher interest rates and a slower economy. After them, a correction works its way up to the Generals. Below are some of the well-known companies with solid earnings and their returns from recent highs:
Service Now -39%
A lot of damage has been done obviously, but there are plenty of signs that we may be entering the final phase. Seeing the Generals go down is typically a hallmark of late-stage washouts. Consumer Staples, Energy and some Utility stocks are still positive for the year, but they don’t necessarily have to collapse. When institutions determine a bottom is at hand, they will be used as a source of funds to get back into favored growth plays, but that doesn’t imply Coca-Cola# needs to drop by 50%. Sideways or slight pullbacks are likely for those that have held up.
Let’s go into the weekend on a positive note. Although we may not have seen the exact final bottom in major averages, there are other signs we are getting close and we can see numerous decent entry points today:
• Retail participation is collapsing. We’ve all heard stories of cab drivers making millions on dotcom stocks during the Tech bubble of the late 90’s. That didn’t turn out so well. Same for Uber drivers this past cycle, trading crypto while dropping off passengers. Froth like this ends when the average investor capitulates. Morgan Stanley noted that last Friday was the 5th largest sell day on record. Institutions were net buyers. Who do you think has better information and analysis, the Uber driver or institutions with a treasure trove of data?
• The S&P has fallen for five straight weeks. Six weeks for the Dow Jones. If markets don’t bounce significantly today, it will be another negative week. You have to go back to the bursting of the aforementioned dotcom bubble to find another period similar to this. Prior to that, you need to go back to the October crash in 1987. Historical records show the next year is positive by a wide margin.
• Although CPI and PPI were elevated, they both gave confirmation that inflation is peaking. Expect the trend to continue going forward.
• Valuations are becoming more attractive. Note, they aren’t all “cheap” yet, but may not get there unless we truly enter a recession. Growth in earnings per share is still going to be high single-digits this year. Facebook, Qualcomm, Netflix, JP Morgan#, Best Buy# and Comcast# are all trading below 13X forward estimates. Numerous others are even cheaper. Long-term opportunities are being created during this wave of selling pressure.
• Over one third of all stocks are below their pre-pandemic prices. As if the past 2+ years never happened. Sure, many got to extreme multiples, but look at Disney# for example. The stock is even below where it was when Disney+ was introduced. I think Mickey Mouse will make it through any downturn. They are actively turning away customers at parks which are jam packed. Eventually, the streaming side will work itself out. I know my kids can’t get enough Star Wars content.
• For now, it looks like we’ve passed peak hawkishness with respect to the Fed. Many were pricing in two 75 bps rate hikes over the coming meetings. That probability is down to near zero, at least for June. Maybe inflation ramps back up and the Fed has to go nuclear, but for now we have a clear playbook over the next few months. Knowing the information, even if it’s bad, is better than not knowing.
• Over half of all stocks are already down 20%, which technically is a bear market. Returns, after this type of decline, are quite positive based on history.
• Everyone is already bearish. There are more bearish advisors than bullish, with some surveys even worse than during the Covid lockdowns. This is a contrarian indicator, but has worked quite well over the years. “Buy when there is blood in the streets” is a famous euphemism mainly because it works!
• Stocks are severely oversold, with only 15% of Nasdaq stocks above their 200-day moving average, as much as market bottoms in 2002, 2009, 2018 and 2020. All were great buying opportunities.
Although it is easier to notice a V-shaped bottom and ride it higher, markets don’t always give that option. We don’t think this is THE exact bottom, but gradually putting some excess cash in names that have been crushed over the coming days/weeks makes some sense. This will end at some point. There are plenty of signs that the process is almost complete. Seeing the last of the Generals get hit could be the main indication the worst is over and the repair process can begin.
Disney star, Debby Ryan is 29 today. The new Batman, Robert Pattinson, turns 36. Stevie Wonder is 72. Stephen Colbert is 57.
James Vogt, 610-260-2214