Research Notes: A Gloomy Plea And Large-Cap Values
Preparing for the worst, and the big names that still aren't cheap.
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In late March, in the first post on this site, I expressed a significant amount of caution toward the U.S. equity market. “I don’t believe this market is at a bottom — or even ready to bottom,” I wrote.
The S&P 500 is down 20% since then, in less than three months. And I still don’t believe this market is at a bottom — or even ready to bottom.
Yes, stocks are cheaper. They’re not cheap enough, as we shall see in a moment. Meanwhile, the last 11 weeks for me, personally, have included a pair of realizations that have turned caution into outright fear. Days like today (S&P -3.6%), or Monday (-3.8%) or last Thursday (-4.1%) to me look like other investors coming to those same realizations (or perhaps a few of their own).
First, things are breaking. A post that went viral via Twitter highlighted significant stress in the mortgage bond market.1 Cryptos can’t hold their peg, and now neither can the Japanese central bank. Yield curves are inverting, and the S&P has declined over 3.5% in three of six trading sessions.
There’s nothing healthy here. This isn’t an orderly correction. And while this is kind of a bullsh—- argument, it simply feels wrong. I’ve seen this pattern before, and it’s not the pattern of Q4 2018 or the summer of 2011. It’s the pattern of fear, of error, simply spreading from market to market to market, as was the case in 2007-2009 and (though I admittedly had little focus outside of equities, or any real experience at all, so I could be wrong here) 2000-2002.
The one major hope in late March was that the clear bubbles in the market could be contained. Indeed, at that point the bubble in retail-favorite growth stocks already had been deflating for over a year. Obviously, that hope was misguided: the possibility of containment has turned into the reality of contagion.
The second is that no one is coming to the rescue. I don’t subscribe to the idea that the Fed is the be-all end-all of equity prices (in fact it drives me a little nuts2), but our financial oracles seem to have missed the mark this time around, and now look to be hopelessly behind the curve. Even once the Fed catches up, its toolbox seems to be empty. Any rational or even modestly helpful response in terms of fiscal policy seems unlikely, to put it mildly.
The only thing even working right now, oddly enough, is the consumer. That’s changing. Sentiment is at a decade low in the U.S. It’s back to pandemic levels in Australia, and the lowest on record (or the 1970s, depending on the source) in the U.K. Inflation is a problem; layoffs soon will be another. Even the crypto bust matters: the $2 trillion in lost paper value is over $250 for every man, woman, and child on this planet, and on average (very roughly ballparking it) $2000 hit to households in developed nations. Obviously, the distribution of that hit is rather uneven, but the overall impact (something like 2% of annual world GDP) is not insignificant.
Simply put, we’re in trouble. I’m not alone in believing so. There’s a lot of commentary out there to the effect that the sell-off is only beginning, that this is March 2008, not March 2009, or June 2000, not June 2002. Those dates aren’t pulled out of thin air: the two periods to which this market gets compared most often are the dot-com bust and the Great Recession.
The comparisons make some sense. Both the late 1990s and the mid-2000s had clearly defined bubbles, driven by accommodative Fed policy. But taking a broad step back, the big risk here is not that this is 2008 or the second half of 2000. Investors who bought during those times were early — but they quite often got made whole again relatively quickly, as we discussed last month.
But the comparison here that seems more apt — while also portending the worst news — is that of the 1970s. Oil shocks and ‘stagflation’ obviously underscore that comparison, and it’s not a helpful one. The stock market was broken for years, falling steadily on exceptionally thin volume. From 1969 to 1982, real returns in equities were negative 11.6 percent.
There’s an underlying optimism to the 2000/2008 comparisons: those markets to at least some extent saw V-shaped recoveries. (The shape of the recovery post-2000 very much depended on an investor’s portfolio, admittedly.) The 1970s, however, were bleak for a very long time. And this economy, this market, right now has that risk. What asset classes are safe? Energy is the only thing that is outperforming — and energy historically gets crushed during a recession.
Corporate earnings are coming off what looks like it might be a peak in terms of profit margins. The consumer has too much stuff, and in many cases now too much house (at least financially speaking). We had (roughly speaking) a 40-year bull market in bonds, and, what, a 75-year bull market in housing? What does the bill for those runs look like when it comes due?
The possibility of a lost decade (an investor can throw post-1980s Japan into the mix here too) or something like it is obviously real. And where the comparison to the 1970s, and/or the prospect of years of economic and financial stagnation, gets truly frightening is that the 1970s were bleak in ways far beyond the equity market. One only need to see the movies of the era to get a sense of the post-Watergate mentality. It was rough enough that Jimmy Carter supposedly gave a speech about our national “malaise”, but the use of that word never actually occurred: U.S. society put in place retroactively.
I’d ask any American a simple question: what does our society look like with economic dislocation piled on top of what we already have?3 Our politicians are lying in what seems to me an entirely new way: lying not about what will happen (solving poverty, driving 5% GDP growth, etc.) but what is actually happening (price gouging, elections, etc.). Crime is rising, not just in cities but in rural areas as well.
We don’t trust each other. I’m not sure we like each other. So much of the content we see (whether in social media or traditional media) is geared toward anger, toward saying “it’s their fault.” How much of that content will there be, how much of that anger will be there be, when significant economic pain is added to the menu of problems facing this country?
* * * *
Maybe this is all too bleak. America is resilient. So is the world. Over time, the stock market keeps going up. The housing market will recover; in our pitch on Quanex Building Products (NX) we noted the significant housing shortage in the U.S. (one echoed overseas as well), a shortage that has to be solved at some point. America has been counted out before; as pessimistic as attitudes were in the late 1970s (Carter won just 41% of the vote, with Reagan and conservative-ish independent John Anderson claiming over 57%), the 1980s were an ebullient, sunny decade.
But there is a scenario in which things get very dark for a very long time. That’s not a scenario in which investors should be trying to “time the bottom.” It’s one in which they should be preparing for the worst, and simply trying to survive until we make it through to the other side.
That’s not a scenario that’s guaranteed to happen. It’s quite obviously not a scenario that I hope will happen. It’s a scenario, however, that we all need to at least keep in mind, and make sure we’re properly prepared for.
According to a finviz.com screen there are 79 (more than 10% of the total) large-cap stocks down 40% or more so far this year. (I believe that data is at Wednesday’s close.)
Bringing this discussion back to investing, there’s a pretty big catch here: running through those names does not show a lot of obvious value.
Surely, some of those stocks will rebound. It’s likely a handful will deliver triple-digit returns over the next five or ten years. But I ran these screens in 2001, and 2019, and 2010, and 2018, and April 2020. Without exception, there was obvious value there.
Quality companies had dipped 20%, with earnings multiples returning to seemingly attractive levels. There were always “wait, why did this name get sold off?” candidates.
They aren’t there. Look at the fundamentals of the 20 worst large-cap stocks this year:
Eight of the stocks still are expected to be unprofitable next year. Of the remaining 12, the average forward P/E is 127x. The average P/S excluding Rivian (RIVN) is 8.4x. The ‘cheap’ stocks — Snap (SNAP) and Netflix (NFLX) most notably — have forward P/Es of 20x and 15x, respectively, but the market likely doesn’t trust consensus and/or those estimates haven’t yet been updated in public data.
The market cap figures are telling as well. On its face, is Coinbase (COIN) attractive at $12 billion? Etsy (ETSY) at $10 billion sounds about right. Snowflake (SNOW) still is worth $42 billion; Rivian $27 billion.
Again, there will be some value here. I’m still bullish long-term on AppLovin (APP), our first deep dive. Align Technology (ALGN) seems like a name that can ride out volatility and come out well the other side (though that’s not a simple story).
But it bears repeating: when the bottom is near, these kinds of screens (and this is just one example of a trend) highlight all sorts of valuations and multiples that jump out instantly. What tends to happen is that an investor starts looking for reasons not to buy due to the fact there are so many opportunities worth exploring.
Even looking for names on the basis of something other than steep declines (and thus anchoring bias), we’re not at that point. We’re still in the “looking for reasons to buy” phase. We haven’t bottomed yet. There’s more still to come. Plan accordingly.
As of this writing, Vince Martin is long shares of AppLovin and Quanex. He has no positions in any other securities mentioned.
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As is the nature of Twitter, there was some pushback as to whether the market truly went “no-bid”, or if trading was just a little wonky.
I find nothing stranger than investors who believe Fed policy explains essentially all of the movement in the equity market — yet a) often want to fight that policy and b) choose to play that thesis in the equity market, rather than elsewhere.
I’d bet those outside the US are asking a similar question, though as a typical American I admit to some ignorance of social conditions outside our borders.