"Great company, bad stock." There. Get used to that phrase, especially you newer investors, because companies' valuations are diverging wildly from what you think they are worth and you are befuddled and angry.
I am here to explain why bad things are happening to good companies, and that as cruel as these moves are, they make a ton of sense when you understand their context. To do this, let me give you some history.
Right now there is a lot of contempt, especially among younger investors, for people who wear suits. I think it's a completely nutty thing. I mean, I wear a suit because I was told to wear a suit when I got to Goldman Sachs (GS) 40 years ago. I didn't do it right, I had a corduroy suit I had bought at Marshall's as well as a button-down shirt with no French cuffs, no handkerchief and no T-shirt. If I remember correctly, my partner, Walter, told me to go right away to Moe Ginsburg's to get some real clothes. He was so mortified to be in the same room with me. I think he was willing to give me $500 if I left at that very minute.
Anyway, I learned what to wear, but, I would say, more importantly, I learned why stocks move and how counter-intuitive it all was. My teacher, David Darst, you have seen him on CNBC, was explaining to me, what was the most key determinant of stock prices. I first answered profits. Nope. Sales? Nope. Management? Nope.
He said, no, no, no: the bond market, in particular, the Treasury market. It is much, much bigger and everything, every asset, including stocks, is priced off of it. One of the things that makes interest rates go up is inflation. You need more yield to get compensated for that inflation. Stocks are what are known as long-dated assets. They are valued less -- the asset erodes in value -- particularly if it is an asset that has no dividend or no earnings and is priced on sales, not profits; "priced on," meaning it's a key reason in how managers arrive on a price to pay for a stock.
So, David told me, first look at the bond market to figure out what something is really worth vs. what it is selling for. If rates are going up, that stock is going to go down, unless it is a beneficiary of inflation of which so few stocks other than mineral and maybe oil stocks might be. Similarly, if rates are going lower, that means inflation might be more tame and long-dated assets will rise, especially ones with tremendous hopes for success, even though they don't have it now. A company that can pass on inflation inputs because it has a terrific brand name, companies like Procter & Gamble (PG) or PepsiCo (PEP) , do better than those that can't. Companies that have modest or no revenue will get a haircut each time rates go higher. A dividend can help block the decline, but as rates get higher to where dividends aren't competitive, then dividend-offering companies get hurt, too. The worst stock performers when rates go up? Those of companies that are growing rapidly with no earnings in sight, but trading on the momentum of the direction of the bond market, as well as their individual prospects.
Or, to distill it: If Treasuries go down in price, because of inflation, your highest growth stocks will get crushed, but there could still be a bull market in the stocks of resource companies and those that help extract them, because they can keep pace, despite the erosion to paper assets.
Wednesday morning we got an inflation number, the consumer price index, that was not red hot, it was white hot, like the crucible at a steel mill. Sparks are flying everywhere. It's the type of thing that moved yields higher, and called into question whether the Fed, which has been keeping rates low, should throw in the towel and accept that commodity inflation must be stopped by slowing the economy, maybe even as the risk of recession. Yes, that drastic, especially in the grains, petroleum-based products, protein products, semiconductors and anything car and truck.
So, now we have to go right to the heart of the beast. There are certain companies with long-term prospects that were very right. When inflation was tame and rates were low -- the 2020 scenario, of course, aided by COVID-19, which caused everything to plummet -- these long-term prospects were worth a great deal. Buyers large and small rushed into the stocks of companies that aren't making money now, but have rapid sales growth that didn't need a strong economy -- companies like Unity Software (U) and Roblox (RBLX) on Tuesday night, the gaming platforms, one known to the real deep gamers and the other to children. Both companies are crushing it in sales, but are thinking big and not even trying to make profits right now. Way too much opportunity.
Man, does this market loath this kind of stock right now. Not the company. Just the stock. Many younger investors and those drawn to stocks in the way people like to bet on hot teams, own these stocks. They can't bear to look at them right now. That's unacceptable. There could be a level where commodity prices, the source of inflation, peak. Some may have already, including semiconductors that go into personal computers and lumber, which had been a leader in price. That's a start, but there are so many commodities that continue to shoot up that you get that kind of consumer price index we had Wednesday.
What are some other stocks of companies that are being crushed by the dynamic? I have a list of them, but before I give them to you, I want to tell you that the companies are great, it's only the stocks that are bad. With that shibboleth, here's the list: Tesla (TSLA) , Teladoc (TDOC) , Square (SQ) , Roku (ROKU) , Shopify (SHOP) , Zillow (Z) , Twilio (TWLO) , Spotify (SPOT) , CoinBase (COIN) and Exact Sciences (EXAS) . You might say that's a list of companies with chief executives who, with the exception of CoinBase -- too new -- I have interviewed. But the commonality is that they are the largest positions of the once hottest portfolio manager in the land, Cathie Wood, of Ark funds (ARKK) . These are Woodstocks.
Even as that might be a humorous moniker, I am not speaking with contempt about the Woodstock companies. I am speaking with wariness and skepticism about their stocks, because of what I learned 40 years ago, in the great class that was Goldman Sachs. These stocks are almost fated to go down and the saving grace of Wood is that she states that they are long-dated assets, and if you wait a long time, they will make you money. That may be the case, but this market is impatient, and these stocks have many more sellers than buyers, so they go down.
When does this end? When the sources of inflation end. With the exception of the two I mentioned, two important ones but not that important, we are just now beginning to spiral out of inflationary control.
That means that these stocks will go down, punctuated periodically by rallies from when we get a slower economic number. There will be far fewer of those, though, and far more with days like Wednesday. Get used to it, or cut your losses on the next move up because we are in a new market, so different than last year and as Bob Dylan says, the times they are a changin'.
