It seems like eons ago we faced the terrible Covid market declines which saw the Dow fall from close to 30,000 to a low of 18,000 in a matter of 5 weeks. I vividly remember as day after day, markets gapped lower forcing circuit breaker halts in order to slow down the selling. While market frustrations ran high, it paled in comparison to the general fear wafting through the air regarding health and safety. One evening I made the mistake of reading a medical journal outlining an opinion of events which would transpire leaving a population decimated and a great depression as a forgone conclusion. I spent time that same evening thinking about previous market events, which correlated with near economic collapse, recounting how fear and irrational behavior ended up being a terrible investment strategy. We remained calm, with a steady hand on the proverbial investment wheel and navigated the carnage well.
While the Dow now sits around 33,000, or 10% above previous highs set prior to our Covid decline, the recent selloff from 37,000 has the painful feel of anything we’ve gone through in the last several years. The only question is, are we near the end of this slide or just the beginning?
The biggest issues facing the markets at present ironically have nothing to do with an economic catastrophe as we’ve seen during either the Covid decline or the Great Financial Crisis. While inflationary pressures are of concern, these pale in comparison to a credit crisis in which the entire financial system was on the verge of collapse. From my vantage point, we now have a situation where the Federal Reserve is desperately trying to remove some of the excess liquidity they have delivered over the years and markets are throwing an absolute fit.
Just yesterday, as the Federal Reserve raised interest rates by ½ of 1%, markets cheered the idea that Jay and company would take a ‘measured approach’ to further rate hikes thereby allowing the ‘data to guide them.’ When asked directly if 75 basis points was in the cards, the answer was ‘no’ to which the market smiled and stocks were bought.
Overnight however, it was as if the mood shifted dramatically, leading investors to realize that despite this ‘measured pace’ further rate hikes were still on the table and therefore stocks must now be sold. As markets will often do, the buying frenzy of Wednesday turned into a selling frenzy less than 24 hours later.
Despite the unpopular opinion, I remain in the camp that our Federal Reserve will not break the economy in order to slow inflation. Over the last few weeks, commodity prices have fallen considerably thus indicating inflationary pressures are already on the decline. My belief is that once the Fed sees this, they will take a victory lap stating their policy is working when in reality the supply chain is loosening up and stimulus payments have run their course. At this point, rather than press the gas on further rate hikes, it will be important for the Fed to continue to cite the data as their guide.
We’re quickly entering the area where stocks are becoming attractively valued. Take Toll Brothers (TOL) for instance. Despite the recent housing market, this stock has fallen from a high of 75.61 in December to a low of 45 just a few weeks ago. This 40% decline is a direct result in interest rate concerns and now has the stock trading at forward earnings multiple of 4. As Buffett says, you must think of owning stocks like owning the business. Well, if you were to have the capital to buy the entirety of Toll Brothers, the profit generated each year would pay for your entire investment within 4 years. Historically, this is around ½ of the historical value for this company, putting in context just how cheap the stock has become. While I’m not advocating housing stocks, I’m only using this as a general proxy to understand what the market is pricing in when it comes to the economic picture should we continue the path we’re on. Toll Brothers price action is not just suggesting a housing slow down but a housing collapse. I’m struggling to consider how we see a collapse with such a robust employment picture and consumer.
On the other hand, the NASDAQ 100 is now off over 21% for the year taking some of the previous tech darlings down 50, 60 or even 70%. The carnage in these names has been similar to the dot com decline of 2000 with stocks like Paypal (PYPL) down 72%, Shopify (SHOP) off 76% or even the mega cap Facebook (FB) down 46%. I struggle to believe that these companies will be packing it in and folding up shop any time soon.
In summary, I believe the market is throwing a fit regarding our tough talking Federal Reserve and across the board selling is quickly putting us into a place where opportunities are present. The selling is intense, the frustrations are high, and the losses are not fun; however, it is precisely the time when, historically, it has paid to look for opportunities rather than exits.
I thought the following chart from JP Morgan captured market volatility well. The data displays intra-day declines versus calendar year returns. While this decline is not fun at all, you can see it is far from abnormal.
These next few days will be important as we see how the market digests this recent decline and I suspect I’m not the only one looking for bargains. Hang in there, as most of you know, while these times in the market are unpleasant, they make us appreciate the positive runs so much more, which I believe will most definitely come again.