The Rollercoaster That Is The Stock Market

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The Stock market over the past few months has turned into a sea of red, with the markets sloping downwards for the third consecutive month since November. Should there be a reason for concern, or does this play into the grand scheme of things? 

Firstly let’s reclarify that the market is very much based on sentiment and emotion, and currently, it appears that the overall outlook for 2022 seems to be pretty mixed, from the reopening of the economy to the increase in interest rates, the market seems to have a hard time pricing in so many uncertainties. This has ultimately led to strong volatility in the near term. 

Although there is no telling what direction the market is heading in the foreseeable future, we listed a few assumptions that could be the reason as to why the market is strongly pulling back.

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The Reopening Play. 

In our previous article, we had mentioned that the Omicron variant could play a pretty big role in the reopening of the economy, mapping out two key scenarios. 

The first scenario assumed the worst for the reopening of the economy indicating that if omicron persisted, then that could potentially throw the economies back into partial or full lockdowns, putting pressure on the fed to retrieve on their interest hikes. 

The second assumption took into consideration the infection rate of omicron could act as a shortcut to so-called herd immunity. Allowing economies to fast-track themselves into quasi normality with little to no restrictions on travel and business.
As things stand it appears that the second assumption is gaining traction with some EU countries planning to reopen their economies in the near future, following the footsteps of the UK. 

If the economy seems to be on the final stretch out of the pandemic and into normality, it would be normal to assume that the re-opening plays would benefit from this, and thus, result in a rotation out of the stay-home stocks into re-opening plays such as travel and hospitality stocks. 

The above assumption could be one of the reasons why growth stocks have been negatively impacted recently, as a rotation of money by the big investors has seemed to have taken effect. 

The Interest Rate Increase.

With the economy now starting to reopen, the fed will be more likely to increase their interest rates as a remedy for the current inflation spikes driven by supply shortages, and the current debt overhang that was brought about by the Covid-19 pandemic. In fact, the first proposed spike appears to be on track for March 2022.

As mentioned in other write-ups, when the fed increases interest rates, it tends to benefit lenders of finance such as banks. This is because the cost to acquire debt and other forms of finance are more expensive, hurting profitability margins for borrowing companies, but quite the opposite for lending companies. 

When we invest in a stock, we pay a premium for that stock. This is because we assume that the company we are investing in will grow at a certain rate (%) for years to come. However, when growth is impaired cause of such occurrences, then the premium to which investors are willing to pay needs to be reassessed. If investors are assuming that a slowdown will occur, then the willingness to pay such premiums is diminished across the board. 

Therefore with that being said, organisations with large amounts of debt will be more likely to have their profitability margins impaired, and analyst targets slashed. 

In addition to this, it also provides investors with opportunity costs to consider. Investors may be willing to shift their investments to the bond market to benefit from the increased interest rates, as opposed to bearing the risks of the equity markets, however, as we mention later on in this post, economists believe that negative rates will be deployed in the long-term, thus being to the benefit of financial stock markets.

Switch to Value Stocks 

In the light of all the uncertainty investors have returned to the safe havens that are the value stocks. 
Organisations that have proven business models, strong balance sheets, and strong free cash flow tend to uphold their valuation a lot better in difficult times. Not only this, in times of recession, these organisations tend to accumulate even more market-share as smaller competitors either die off or are acquired by the big players, making them the better long-term partner.

However, despite this, the current battering of growth stocks may indicate that good bargains may emerge in the near term. Valuation multiples have come down by a reasonable amount in the past month making some companies look like pretty good deals in the grand scheme of things. 

So one may beg to answer the question, should you have more value stocks or growth stocks in the long term?

And the answer is — you should have both.

The actual rate of inflation increase, and its persistency has caught most central banks by surprise, however, despite the increase in pressures brought about by inflation, many economists believe that negative rates will persist in the long-term to the benefit of the financial stock markets. However, this remains to be seen.

To wrap it all up

The current market sell-off has been brought about by more than one factor. In addition to this, the federal reserve has more than one pain to deal with. On the one hand, the supply issues seem to have a long way to go before any resolution, perhaps leading to persistent inflationary pressure into the foreseeable future. Whilst on the other hand the economy needs to tip-toe around a possible major recession, and even worse stagflation, whereby prices continue to rise but the economic activity does not render the increase in prices (taking into consideration the rates of unemployment). This could have significant impacts on the market. 

Advice from leading investors is to caution around investing, assess relevant investing multiples, and keep those top-quality businesses with strong fundamentals within your portfolio for the long term.

Just remember, better opportunities arise in a bear market than opportunities that arise in a bull market.

Not sure what multiples we’re talking about? 
No problem — refer to this link to find out

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