As an equity trader for the last 30 years, I often use that experience to recall a similar past situation that most compares to the current market condition.
There's no doubt that today's market is challenging to navigate, with similarities to past difficult markets for several key reasons:
- Interest rates are set to rise
- The Fed intends to reduce its balance sheet
- Inflation and commodity costs are uncomfortably high
- Geopolitical tensions
- Post-bubble trading action
Bubble, Bubble Toil and Trouble
For starters, the market is digesting a post-pandemic bubble.
The headline names are well known, those such as Zoom (ZM) , Teladoc (TDOC) , Peloton (PTON) , DocuSign (DOCU) , etc. These companies and other tech stocks were rewarded enormously, and the market is coming to terms with the reversal of the over-exuberance.
The market-cap losses of widely owned stocks, like Netflix (NFLX) , PayPal (PYPL) , and Meta (FB) are staggering, which takes time to digest. Years after the Nasdaq Bubble of 2000, tech valuations remained subdued. I would expect investors to be far more discerning of tech valuations for quite some time.
The market is also digesting the downfall of SPACs. Super-hot IPOs were a feature of the Nasdaq bubble unmatched in the recent pandemic bubble. However, the enthusiasm for SPACs came close. Like the infamous Pets.com of 2000, SPACs brought multitudes of low-quality companies to market. The daily erosion in the value of this cohort is staggering, hurting investor sentiment and portfolios. The cash-burn and reigned in expectations of many of these companies will continue to reflect poorly on Wall Street.
The last bubble the market is still working through is meme stocks and cryptocurrencies. Unquestionably, there was money to be made owning these assets, but many of them required masses of unsophisticated investors participating. There seems to be less capital allocated to these investments in a rising interest rate environment, yet they linger in portfolios awaiting the next wave of exuberance. Overall, this seemed like momentum investing leading to a misallocation of capital into things impossible to value.
After a bubble bursts, there's usually a period where all hope of recovery is gone. This takes time, and I don't believe the post-bubble areas are fully through that stage.
Don't Fight the Fed
Wall Street consensus believes the Fed has stimulated the economy too much for too long, leading to inflation and a Fed well behind the curve. Just like the saying, "Wall Street has predicted nine of the last four recessions," there is an overhang of pessimism about stagflation. Who knows if this take is correct?
The economy will be the best indicator of the direction of stocks, with some slowdown baked in. Any economic and Fed clarity will likely have a strong market reaction.
Historically, many market bottoms occur when geopolitical tensions flare. Often it pays to be an investor with a shopping list upon geopolitical-related pullbacks.
The skirmish in Ukraine brought a classic "sell the rumor, buy the news" event along with minor economic consequences, like a strong dollar, slower Fed rate hikes, and higher agricultural prices. Headline risk and fears for the fate of the Ukrainian people, and a possible template for China to invade Taiwan, can justifiably drag on sentiment.
The current market has many moving parts to contend with. In general, uncertainty and a tough tape keep investors' long exposure lower than normal and holding extra cash. There are some good ingredients for a strong rally if the economy holds up well, but also plenty of cause for continued choppy markets.
Indiscriminate selling leads to opportunities. Yet, I would avoid stocks that still have post-bubble or SPAC-related digestion while buying the weakness of high-quality stocks with solid cash flow. A flight to quality and elevated volatility bodes well for the top large-cap tech stocks, which will ultimately help market averages.