If you were too scared to buy stocks last week when investors panicked, I’d suggest selling a little now to free your nerves — and capital.
I’ll be a buyer on the next leg down like I was on the last leg down. Otherwise, I think the market is in no man’s land right now, and I plan to sit still for the most part.
For the bigger picture, here’s part of the first-quarter letter I sent to my hedge fund investors in April, before stocks were fully down:
“The list of stocks that look like great investment opportunities is slowly growing, and amidst the rubble I expect to find several stocks that can rise 10x to 100x in the coming years. In times we are heading towards, great fortunes are being built.”
Now let’s talk about the here and now. If I analyze the market top down and look at the S&P 500 SPX,
Things still look bleak. Analysts still think the S&P 500 will expand earnings to around $220 per share in 2022. Take 10% to 30% of that for the likely profit cuts for some companies as margins go down (higher costs) and demand goes down and you have profits of $180 or so.
Markets have traded at an 18-20+ multiple of those gains for the past few decades while inflation has been low and, more importantly for multiples, interest rates have been extremely low.
As interest rates rise, US Treasuries and other debt securities become more competitive, making people willing to pay lower multiples for stocks. So let’s say we should expect a multiple of 15 to 16 times that income (and that might even be generous if interest rates stay up here or even rise). In math, take 15 to 16 times 180, which equals 3,200 to 3,380 points for the S&P 500. It’s currently trading at 3,790, which means the S&P 500 could fall another 15% and is still considered around fair value.
Then again …
Analyzing individual stocks I like from the bottom up, I like the action. Let’s use two names I built recently, Adobe ADBE,
and ShockWave Medical SWAV,
Shockwave isn’t at all like ADBE, but it’s an interesting comparison. Shockwave has a new biotechnology that will break into new markets, largely paid for by the government’s ridiculously favorable rules on healthcare companies, which give them an 85% gross margin. ADBE has software for its core business that has almost no additional cost when you acquire a new paying customer. This company also operates at 85% gross margin with no government setting its prices. Anyhow, Shockwave is set to grow 40% or more over the next few years as it penetrates new hospital systems and more doctors are likely to adopt its technology. Adobe will continue to grow in the high single digits or low double digits — you name it 10%. Shockwave is set to go cheap in five years. It’s pretty expensive now. ADBE is cheap now and getting cheaper, but slowly.
When I look at the near-term economy with all its challenges, including higher interest rates, inflation, Silicon Valley depression, Russia-Ukraine war, supply chain crises, real estate and other overvalued assets, the outlook is also bleak.
On the other hand, long-term investors need to consider the following: Big companies have spent the last few years figuring out how to make their supply chains more resilient and redundant by moving at least parts of their production to more countries in Asia, Eastern Europe and Central/South America – and of course the relocation of a large part of the supply chain to the USA
And interest rates are already close to natural levels for the first time in decades – that’s healthy!
And inflation has probably already peaked, although inflation itself is unlikely to return to 2% this year or next. But it could happen at some point as these new and improved supply chains remove global shortages and inventories return to healthy levels as prices are lowered to clear existing overstocks in many sectors.
And many companies like Alphabet GOOG,
and Adobe are finally rationalizing their workforce bases and will likely see higher operating margins in many areas of their business once the transition period is over.
And crypto is finally washing out.
And just last week as we followed our playbook and bought stocks, fear was everywhere and the bears were bragging about how brilliant they were and the bulls were giving in to them.
Our largest positions at the time of writing include, in alphabetical order: GOOG, Intel INTC,
Rocket Lab USA RKLB,
Rockwell Automation ROK,
and Uber Technologies UBER,
For the first time in a long while, I covered almost all of our short positions as markets plummeted towards the end of the quarter, initiating an additional long exposure for the panic action as planned.
I will judiciously try to add more shorts and/or hedges over the coming days and weeks. My expectation is that individual stocks will no longer be as broadly traded and that stock selection on the long and short side will be more important for the next cycle.
Be careful out there. Some stocks have bottomed, others are about to bottom. We’ll look back in a few years and be glad we took advantage of the wide sale. But we’ve already had this tremendous recovery from these recent lows and we should be prepared for more volatility and perhaps more downside as a path of least resistance in the broader markets. Be prepared to keep buying on the dips, especially if they get as extreme as they did last week.
Cody Willard is a columnist for MarketWatch and editor of the Revolution Investing newsletter. Willard or his investment firm may own or intend to own the securities identified in this column.