Turn and Face the Strange
Ch-ch-ch-ch-changes
Turn and face the strange
Ch-ch-changes
There’s gonna have to be a different man
–David Bowie, “Changes”
If you thought that the beginning of 2022 would be volatile, then you were right on the money, literally. You see, in this business, being “right on the money” is what I attempt to do each day, week, month and year.
Now, for much of the past two years, and certainly since the March 2020 pandemic lows, the equity markets have trended higher on a bullish combination of 1) A very accommodative central bank, 2) Fiscal stimulus via big federal spending/giveaways, 3) COVID-19/vaccine optimism and 4) Strong corporate earnings.
I’ve written about these four bull market factors in my newsletter advisory services with the biblical reference, “The Four Horsemen,” as their presence escorted the bulls on their trek through Wall Street and the American and global economies for much of the past 22 months.
Yet as David Bowie famously wrote in his classic song, “Changes,” sometimes we must turn and face the strange, and if necessary, become a different man.
So far in this nascent year, one that is not yet even one month old, we’ve already witnessed aggressive gyrations that have created massive changes in the major domestic averages.
Through the close on Tuesday, Jan.25, the Dow Jones Industrial Average, S&P 500 and Nasdaq Composite all were firmly in negative territory year to date. The Dow was the best performer over this period, but it was still down 5.62%. The S&P 500 has already witnessed an 8.60% pullback, while we saw big selling in the tech-heavy Nasdaq Composite with a loss of 13.46%.
The big losses in the higher-valuation, tech-heavy Nasdaq are all you need to know to understand the changes we face here, changes that are no longer supported by two of the four horsemen (a very accommodative central bank and fiscal stimulus via big federal spending/giveaways).
In fact, not only have two of the four horsemen basically been relegated to the barn, but there also has emerged a dark presence in the market atmosphere that’s clouding the outlook going forward, and that is multi-decade-high inflation.
Yet, why is it that high-valuation, high-growth tech stocks are getting hit the hardest? Aren’t these the stocks that everyone wanted to own last year? The answer is largely yes, these are the stocks everyone wanted to own, and that’s part of the reason we are seeing the segment sell off here, as these were the stocks that were over-owned for years.
Another reason why there’s been an exodus from growth stocks/sectors to value stocks/sectors this year is because those high-growth stocks also are high price-to-earnings (P/E) stocks. Now, as interest rates rise, a headwind will begin to be created on economic growth. And as growth potentially slows, it hits the highest P/E stocks hardest, because these companies are priced for perfection, and perfection doesn’t include slowing growth.
The high P/E leaves these stocks and sectors a long way from a level that would attract anyone looking for value. For example, a 100 P/E tech stock could get cut in half (50 P/E) and that’s still a multiple double that of the S&P 500. Conversely, a 30 P/E stock could drop to 25 P/E (so less than 20%) and now it’s trading much closer to the overall market multiple and is more attractive to more buyers. Point being, when rates are rising and growth could potentially be slowing, buyers won’t defend the high P/E stocks until there have been big drops.
We’ve seen those big drops occur already this year, as many of these high-growth tech names, best represented by the holdings in the very popular ARK Innovation ETF (ARKK), have tumbled. In fact, ARKK is down over 25% year to date. Yet still, the big holdings in ARKK are nowhere near “value” levels that would entice investors to step back in and defend these stocks at a certain level.
The reason that’s a problem is we have no idea just how over owned the high-growth, high-P/E space is by hedge funds, nor do we know how much leverage there is in these holdings. If the answer to both is “a lot,” then the drop in this sector could cause a bigger market correction.
For astute market watchers trying to determine the next leg higher for equities, the key is watching these high-P/E, high-growth tech names. Stated more practically, if ARKK can stabilize that will be a sign that stocks in this space have declined enough to entice buyers.
Going forward, I will be closely monitoring funds such as ARKK, along with all of the Fed’s actions and market signaling, to determine when it’s safe to turn back and face the strange of the high P/E equity segment. Until then, as investors, we’re gonna have to be a different man and embrace the “quality” stocks out there with more attractive P/Es and better valuations—and hey, there’s nothing wrong with that kind of change!
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Reeducating America, Conceptually
You often hear that education is the key to success. And while I agree with that statement in principle, it’s important to understand that it is the kind of education one gets that really matters.
In the new episode of the Way of the Renaissance Man podcast, I speak with Ed Thompson, a man whose mission is to help reeducate America, conceptually.
Ed is the founder of the Conceptual Education Project, a group spearheading an effort to reform the education system by guiding it away from the current “progressive” philosophy first created by John Dewey, and into a more “conceptual” philosophy.
Jim Woods and Ed Thompson talk “conceptual” education.
The basis of the organization’s program is to help train intellectuals who can articulate and advocate a rational approach to primary and secondary education, with a view to radically influencing how teachers’ colleges teach.
If you are concerned with the current state of the anti-conceptual approach to education that pervades America’s K-12 system, and you want to find out how you can help make things more philosophical, and more conceptual, then this episode is a great place to start.
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On Falling Together
“Sometimes good things fall apart so better things can fall together.”
–Marilyn Monroe
The iconic sex symbol also happened to be a very good actress, as well as an intelligent, thoughtful individual who worked very hard at her craft. In this quote, Monroe reminds us that even good things come to an end, but that just means that there is a possibility of better things to come. Looking at the issue with this kind of positive spin is what can be described as a benevolent sense of life, and it’s one that I embrace. Yes, life is tough. However, your values are achievable if you are willing to do what’s required to nurture those values and make them the reality of your existence.
Wisdom about money, investing and life can be found anywhere. If you have a good quote that you’d like me to share with your fellow readers, send it to me, along with any comments, questions and suggestions you have about my newsletters, seminars or anything else. Click here to ask Jim.
In the name of the best within us,
Jim Woods
