Making sense of today's (PEPT) Politics, Economics, Philosophy, and Technology while enjoying great wines and whiskies in some of the most beautiful places in the world.
Wednesday just before the markets closed I spoke with Charles Payne on “Making Money” on Fox Business about what is happening in the tech sector, video is here. It was a quick hit and there is so much to talk about, so I thought I’d share more of my thoughts here.
So far this has been the worst month for the Nasdaq Composite since the throes of the Great Financial Crisis back in 2008. Markets are going through a reset and investors are forced to rethink valuations as we face a truly unprecedented set of conditions:
Multi-decade high pace of inflation as the economy slows.
Escalating war in Ukraine.
Shutdowns in China that cut both supply and demand at a globally meaningful level.
The USD dollar surging – DXY looks like it is about to break out above the march 2020 peak of 103.
The Japanese yen is falling hard.
First quarter GDP comes out tomorrow and is expected to be around 1% - stall speed.
Keep in mind that when the Fed starts a rate hike cycle, GDP is typically over 3%.
The yield curve (difference between long and short-term rates) is flatter (meaning they are closer) than we normally see at the start of a rate hike cycle.
This will be the first time since 1987 that the Fed has started a cycle with the major equity market indices below their 200-day moving averages.
When we combine the planned Fed interest rate hikes with what is expected for tapering. That translates into around 450 basis points of hikes. We haven’t seen something of this magnitude since Volker, which is who Powell now compares himself to.
This magnitude of tightening translates into a roughly 2.5 to 3 percentage point drag on GDP in 2022 and around 5.5 percentage point drag in 2023.
When you think about all that, it makes sense to see a rethink on valuation.
Yesterday the S&P 500 saw its 2nd largest decline in the past year and the Nasdaq Composite took its worst tumble since September 2020.
Both the Nasdaq Composite and the Russell 2000 have undercut their March lows – a former support level – and the S&P 500 is hovering right around is closing March low.
The S&P 500 set for its worst month since March 2020, but back then we had fiscal & monetary tailwinds in our future, today they have become headwinds
Is it time to start buying?
S&P 500 forward P/E ratio has dropped to just under 19 from 21.5s at the start of the year. This is still pricey, in the 80th percentile by historical data. The only time we’ve been higher than this was during the heights of the dot-com bubble.
S&P 500 Energy stocks closed out last week below where they were on March 8, which may be indicating that the demand destruction is on the way and will reduce inflationary pressures.
Capitulation is not yet here - Barron’s Big Money poll still has nearly 60% believing equities are the most attractive asset class.
Disruptive tech companies like Peloton (PTON), Rivian (RIVN), and Snowflake (SNOW) have dropped below their opening trading price.
I couldn’t be happier to see this because we are going to be able to buy these at a serious discount, what’s not to like?
But, the going is going to be choppy though, so investors need to start buying into their positions slowly
There is no way to time the bottom here, particularly with all the geopolitical risk and potential Fed intervention if things get too ugly.
Why are you so optimistic?
The tech revolution that started in the 90s gave birth to Moore’s Law. This was essentially how we thought about how quickly computers could get better, faster. It was revolutionary because it meant that innovation was happening at a much faster pace than had ever been experienced.
What we experience today is all about network effects - we are now in what my friend Raoul Pal calls “The Exponential Age”
Simply put, the more members there are in a network, the more valuable the network becomes, making it more attractive, which means it will grow more rapidly – at an exponential pace.
We’ve already seen some evidence of this. Many were skeptical of the growth potential of networks such as Facebook (FB) & even Amazon (AMZN), but they grew at a pace that was well beyond what was previously considered feasible because of these network effects.
The absolute poster child of network effects was Zoom (ZM) during the pandemic. Now it is struggling today because it experienced hyper-network effects, pulling what would have been years of growth into just months.
That is something we have seen in a lot of these disruptors, but don’t think that what is happening today means it is over.
Remember what happened with the “Cash for Clunkers” program under Obama. That too pulled demand for cars forward, but it didn’t mean the future was permanently reduced.
The Bottom Line
Conditions have significantly changed so the market is reasonably reassessing valuations. This is a very good thing and will create glorious buying opportunities. Valuations were exceptionally high by historical standards and now that the game is changing, we need a reset. Be patient, look for those things that can benefit from the network effects either directly or indirectly (think semis for indirect), and tiptoe in slowly as it is going to be a rocky ride.
