Despite the ugly tape last week, calm is prescribed
In the run-up from the lows of March 2020, the market leadership rested in the hands of growth and innovation companies, both large-cap growth stocks and smaller companies deemed to be the innovators of the future. Yes, there was a significant move on the part of old economy stocks, but for the most part, it was a situation where they were just trying to recover ground lost in the Covid crash. The move that we saw in the tech/innovators was off the charts to soaring valuations. Meanwhile, in the bifurcated market between tech and value, which had been in the making since 2007, the spread between growth and value performance widened even more (“Growth vs. Value: Historical Perspective,” Anchor Capital Advisors). This disparity appears to be reversing.
ARKK Fund – The poster child for the unwinding
Since February 16, 2021 (peak valuation for the ARK Innovation ETF (ARKK) – $159.70 – Friday’s close, $71.52), the market has begun to perform (as Warren Buffett calls it) its long-term function as a “weighing machine.” This is normal, to be expected and very painful for those overinvested in growth and innovation.
Regardless, last Thursday and Friday (1/20 and 1/21/2022), the fear and panic increased to a crescendo. Investors began to start throwing the babies out with the bathwater… good stocks at reasonable multiples with good earnings prospects. It looked like the beginning of the markets we saw in 2008 and 2020 without a stressed financial system or the unknowns of the newly discovered Covid-19 pandemic. Investor sentiment is in the dumper, with bullish sentiment at the lowest level seen in the AAII weekly survey since July 2020. It registered 21% with the long-term average at at 38%. Last week was the ninth consecutive week below that average and the highest bearish reading in the year (46.7%). All of this sentiment data is very constructive.
The Negatives
The economy – the fact that retail sales shrank 1.9% in December – obviously did not go unnoticed. It is pretty easy to explain, as consumers were constantly told to get their Christmas shopping done early or run the risk of supply chain issues ruining their holiday. Some attribute this to inflation biting into demand. Think about it a moment. People worried about not getting the gift items that they were shopping for would most likely be paying full retail. People continue to point to slowing job growth as another worry. In my conversations with employers, they tell me that they continue to look for people and they are just not there to hire.
Covid – Omicron appears to be on the way out in parts of the country that experienced the onslaught in early December. In the meantime, economic shutdowns appear to be off the table as a response to new variants.
The Fed – The Fed will do what it has to do to combat inflation. Meanwhile, the market seems to be doing that for them. Witness the 50-basis point move in the 10-year yield since the first of the year (1.41% to 1.9% Thursday). It closed the week at 1.77% as flight-to-safety buyers came into the market on Friday’s slide. Don’t forget that oil at $85/barrel should probably be seen as a brake on the economy, allowing the Fed to move more slowly on its planned timetable for increases. Remember, these proposed rate hikes are all “data-dependent.” One final note: current rates are continuing to run near financial crisis and Covid lows – emergency rates! Where’s the emergency?
Inflation – For the past two decades, we have had periods where a main market concern was the potential for disinflation – or worse – deflation. Up until recently, it was a Fed goal to get the rate up above 2%. The biggest loser during this two-decade period was labor. Labor today is in such short supply, I am hearing about huge bumps for hourly workers. $7.35 an hour was a joke, and now it is a relic. It is not unheard of for unskilled labor earn $15-20 per hour, in some cases with benefits. These are life-changing jumps for many people. Sure, higher food and energy costs will eat up a portion of these gains, but the uptick in wages will still easily outstrip inflation. BTW, they will spend every dime back into the economy. At this point, inflation should not be viewed as a negative. Lest we forget, as we move forward, supply chain interruptions – a major contributor to price gouging – should evaporate.
Russia – Their designs on the Ukraine is a problem. Hopefully the threat of sanctions will override Mr. Putin’s desire to put the “Band” (USSR) back together. If it does not, we may be involved in support of proxies in this part of the world for years to come. Much to my chagrin, based on past experience, this will probably not be a bad thing for stocks.
China – China has a pretty good thing going right now. Not sure why the CCP would want to upset the apple cart here. Here is a headline worth noting: “Xi Jinping Rejects ‘Cold War Mentality’ and Calls for Cooperation at World Economic Forum.” Hope he means it.
A Final Thought on Growth vs. Value
According to a paper (“Growth vs. Value: Historical Perspective” – linked above) put together by Anchor Capital Advisors “… if one were to have invested $1 each in value and growth stocks in December 1927, the value investment would today be worth nearly 18 times the growth investment.” (Kenneth R. French).
Since 2007, the value indices, according to Anchor, have been plagued by their heavy weighting in financials and an adherence to P/E multiple benchmarks instead of cash flow growth. Price-to-book value and dividends (sharing earnings with investors through bull and bear markets) are also characteristics of the value camp. To me, the shoe appears to be on the other foot as the growth and innovation trade loses its luster. I believe that secular bull market continues, with value leading the parade.
What’s your take?
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