2022's "Tale of Two Markets" Coming to an End
The Bifurcation of the Markets is Incredible and Isn't Sustainable
The theory of being a macro trader, or investor, is to catch the flow of capital to various sectors based on macroeconomic trends. Essentially, you can use economic knowledge to identify which company’s are going to report good earnings based on a current (cyclical) market cycle. Many retail investors don’t necessarily understand that markets do work in cycles and that stocks can sell off without any real reason directed to business performance.
I’m beginning to believe that growth selling has less to do with macro and more to do with sentiment.
In today’s publication, we’re going to dive into this market and understand 2022’s “Tale of Two Markets.”
Let’s be honest, I don’t think anybody truly saw the market playing out this way nearly 7 months into monetary tightening. For starters, when we look at the major index’s YTD performance we begin to see the real disparity between all of them:
SPY -12%
QQQ - 20%
DIA - 8%
IWM - 16%
The fact that the Dow Jones is only down -8% YTD, compared to the NASDAQ at -20%, should leave us some clues as to what’s going on. When you look beneath the surface and at individual stocks, the story to what is actually happening becomes more apparent. This has nothing to do with macro or economic challenges, it has everything to do with investor psychology and sentiment after a euphoric bubble and elevated valuations.
When we look at the macro picture, it is extremely bearish. The narrative circulating out there is:
Russia/Ukraine was causing supply chain and energy disruption
Federal Reserve and Central Banks all over the world are tightening
China has a zero COVID policy which is further disrupting supply chains
Inflation is at 40 year highs after the liquidity bubble
Interest rates are moving up rapidly, re-adjusting the equity premium
etc (there’s so much more)
Basically, this is a turbulent macro economic environment for many businesses to operate in. However, the reason why this is important is that this has inspired a type of “risk-off” trade which has encouraged fund managers to move toward “value” stocks, or the tride and true big businesses with durable business models. The current market cycle favors these type of stocks because of inflation and general economic uncertainty. It leaves us with many questions like, “how will this business survive higher inflation?”, or, “is this business a survivor or a result of a liquidity bubble?”.
Today, I am under the impression that the stock market is a hell of a lot more durable than most investors think. I am also under the impression that this trade is on its final weeks/months and does NOT reflect what is actually happening with corporate earnings.
Stock Market Sector Price Action
Recently, I began realizing how messed up this market is becoming from a bifurcation perspective. I recently posted this tweet:
I knew I needed to dig in more to get an understanding of what’s going on. My curiosity led me to analyze sectors and individual stocks. I first looked at the major index’s and how far they off from their historical trend line (the 150 & 200 week moving average). The reason why I do this is that it gives some sort of indication of the “mean”. There is no coincidence why the major markets seem to revisit their major moving averages in nearly every bear market since 2008.
The S&P 500 is historically above its major trend lines, which would leave us to believe this is just a minor correction (at first glance)
When looking historically, the S&P always revisits the 150/200 week moving average during periods of fiscal tightening. I am under the impression that regulators (politicians & Fed) don’t want this and can’t have it so they will have the market trade sideways rather than enduring a 30%+ draw down. It’s important to understand American’s (voters) 401k’s are predominately linked to the S&P 500 performance.
The NASDAQ has taken an absolute beating compared to the S&P. The NASDAQ is officially in a bear market. However, the story doesn’t stop here.
If you’re not in the market, it would be relatively easy to dismiss this price action as just “volatility in tech”. This is an understatement as big tech, specifically Apple and Microsoft, have held the NASDAQ up since the beginning. The real carnage beneath the surface of the NASDAQ is devastatingly worse and has produced the worst bear market since 2008 and 2000 - 2003 in tech.
Apple Forward P/E 26x
Microsoft Forward P/E 25x
Apple and Microsoft have both acted as “risk-off” plays during this market considering their valuations are still elevated and price action has held up extremely well. Microsoft is the weaker of the two with Apple still really close to all time highs. Where the NASDAQ gets interesting is when you see a few of the top stocks by weighting. A few examples:
PayPal Forward P/E 18x
Adobe Forward P/E 29x
Netflix Forward P/E 19x
Meta aka Facebook Forward P/E 15x
Salesforce Forward P/E 36x
Etsy Forward P/E 25x
Sea Limited
Guys, these moves are unbelievable. Honestly, we need to go back to the 2000.com bust to see charts like these. BUT, in many cases, this is actually worse because some of these companies dropped 30%+ in a matter of minutes after earnings reports. This price action is historical and those of us who lived through it will be talking about this period of time for years to come in the future. Remember when I mentioned that the S&P 500 is only down 12% on the year? This is the type of carnage that comes from 50%+ declines in the S&P but in many ways, it hasn’t budged. But, why has this been the case?
The Stock Market was in a Bubble, but the Bubble was Selective. But, Where is the Real Risk?
Many experienced investors I follow have mentioned on multiple occasions that this reminds them of Q4 2018. It is similar in many different ways when it comes to missed earnings, fed tightening, liquidity less abundant, etc. Basically, there is no where to hide when the tide goes out. However, with many tech stocks (with long runways for growth) trading at multiples similar to value stocks, we should ask ourselves where risk and opportunity is?
“Risk-Off” Sectors
Utilities are over extended from mean and look to be showing weakness
Industrials are curling over and a reversion to mean seems likely
Consumer Staples looks to be very over extended as fund managers have fled to safety
Energy looks extremely over extended. Yes, Macro favors more upside but it can only go up so far. It’s over extended and politicians are struggling to bring the cost of energy down.
The reason why I showed these sectors was the show the price action in risk-off sectors so far this year. Remember the stocks I showed you above and how they have performed so far. The bifurcation is real. It becomes even more obvious when we look at groups of stocks, ETF’s, that fall in a particular ‘trade’.
“Risk-On” ETF’s
SKYY, Cloud Computing ETF, now trading at the 200 week moving average after significant decline
ARKK, Innovation ETF, is looking like it needs life support. This fund has been bombed out and looks just as bad as the 2001 NASDAQ did.
Russel Growth ETF ($IWO) looks like it has completed a wicked bear market, or at least at the end of it.
Growth stocks, and many other businesses that did very well in 2020 and 2021, have been completely decimated to lows not seen since 2017 - 2019. The ETF’s only tell part of the story, the carnage has been even worse in small and mid cap stocks. But, I am not saying this is without cause. There is logical a rationale to this.
The Federal Reserve Created the Bubble Along with the “Stay at Home” Trend
As many of you may remember, at the bottom of the COVID-19 flash crash the Federal Reserve announced the largest QE program, ever. They announced they would buy $120b in assets on a MONTHLY basis, creating trillions of dollars in new money for the system (government included) to use. This created a sling shot trajectory as liquidity flooded the system and assets were scooped up.
During the summer/fall of 2020, a bunch of people were at home, locked down, away from their jobs, and friends, with stimulus/unemployment checks, it gave young speculators a reason to “invest after a market crash”. This created a flood of speculation and inexperienced investing with no regard to fundamentals. At the time, there was this unusual SPAC craze where everyone wanted the newest and latest SPAC. These businesses would be bought many multiples higher than their intrinsic value with no real business model.
It was nearly identical to the 1999 NASDAQ bubble! Retail (speculator) interest + liquidity = bubble.
1999 - 2003 NASDAQ Bubble
ARKK Innovation ETF Bubble
The comparison between the charts never stop amazing me. They are nearly identical as the bubble pattern, with the blow-off top, formed in both charts. What’s best about this is that we can use history as a guide to get an understanding of exactly what’s going to happen and how much realistic downside we may have.
The “Tale of Two Markets” is Coming to an End
Human nature never changes, this has been more sentiment driven than macro driven. Look at the chart below and compare it to ARKK and the early 2000’s NASDAQ. It’s all human behavior, sentiment, and greed/fear driven. The Federal Reserve popped the bubble in February of 2021 after tightening monetary policy just like they did in early 2000 with a .50 bps hike.
Now we are in the despair phase of a bubble (above), and another image to paint a similar picture is the one below. We are finding ourselves in between the anger and depression phase.
The revulsion of the market toward individual growth stocks is notable and obvious. Market sentiment currently has any sort of growth stock out of favor despite posting impressive results with the business improving beneath the surface of the ticker symbol. In many of the stocks that I own, I believe that by sticking with the core strategy of accumulating businesses with growing:
Revenue
Earnings
Cash flows
My next 5-10 year returns will be enormous.
Combining Macro Factors and Investor Sentiment to Gauge Where We Go Next
I don’t know what the future has for Cathie Woods, or her ETF. Today, she bought more Teladoc stock after it fell 40% on earnings. I am arguably blown away by this move and she may be running an ETF that ends up pulling a similar trajectory to the early 2000’s NASDAQ. The reason why I say this; investors were not wrong about the internet companies of the late 1990’s, they were just very early. They priced in years of gains in a few months. I do wonder if Cathie Woods is right about her innovation platforms.
Regardless of Cathie Wood, our growth stocks, especially in software (with strong business fundamentals), may be in a better position than many of the speculative Genomics plays. I do believe we are at or near the bottom where long term investors are accumulating. Think of it as getting rid of the old and letting in the new. I say this despite:
The S&P 500 looking like it needs to fulfill the downside
Rising interest rates
Slowing economy (I could publish a whole other publication here)
War in Russia
Sentiment is driving the growth markets more than the macro environment at this point. It has already bombed out and there’s a ton of bag holders. Short term downside is probable, but a meaningful leg down seems limited. Even if the markets decline further, I cannot imagine growth falling another 50% from here but maybe another 10% - 20%.
If inflation begins to subside and the Fed begins to back off, sentiment could change on a dime, meaning time is limited. I am under the impression that a new regime, new leaders are forming today for the next major bull market cycle. The worst is likely behind us and there is a real opportunity to construct a portfolio over the next few months. However, this wont last forever.
I’ll keep sharing this accumulation phase and the portfolio I construct for members. I can’t wait to keep you all updated. I will provide another update this weekend. Make sure you guys all….
Stay Tuned & Stay Classy
Dillon
2022's "Tale of Two Markets" Coming to an End
As long I hear "buy the dip", and see people posting incredible returns in last years, we are not done. Mr. Market will teach a lesson those people too, not only those too late to the party (like me). Indexes, have a good 20% to drop, before we can see some light. Now is time of big caps and staples to reset. Indexes have dropped below important levels on Friday. Commercial Traders increased net short positions last week and small one reduced the shorts. All very bad signs. But I hope I'm wrong.
This was well done. Good stuff.