It was not so long ago that the stock market indices were trading at record highs. More and more people were turning to equities and money was coming back into the market after the hiatus due to the COVID-19 Pandemic.
Market experts are perplexed by the increasing momentum of the market on the downside as equities get pummeled daily. But if one looks at the facts the reasoning is quite clear. Make no mistake about its billions upon billions of values in equities, bonds, and cryptocurrency has disappeared. After you let that sink in, you must put it all into context. Yes, context.
Keep in mind that the market corrected upon the lockdown of the COVID-19 Pandemic but in 2020 the markets made a double-digit come back. The S & P 500 itself was up approximately fifteen percent in 2020. Then in 2021, the market moved even higher with hordes of individual investors jumping off the sidelines into the market. As we have warned before with the likes everyone jumping into the water without thinking of the consequences has dire consequences, the pendulum swings both ways. For those that rode the Reddit wave with Gamestop or AMC and made good returns, there are billions of dollars of investors both individual and institutional that lost money.
Then came the rise of Crypto. Additionally, it was then tech stocks that seemed to shrug off rising costs of content and the ability to weather any storm. It is safe to assume when everyone everywhere is talking about a stock, a specific trade, or the movement of a certain investment class, it is time for you to get out.
Right before the internet bubble burst (if you are old enough to remember, I know I am) I went to a party an investment bank was throwing who is no longer around today (kind of sad) and when I went to the bar to get a cocktail, the bartenders were discussing a stock. A company that a couple of us fund managers had positions in. I had a feeling of sheer panic as my body started to sweat. Individuals were jumping into positions that could not afford to lose their hard-earned capital in investments that had a higher risk quotient than they could handle. What happens then, since they are not actually sophisticated investors like funds or other institutions is they buy on the rumor and sell on the news or more importantly momentum. They also do not have the experience the institutional investors have and need liquidity faster.
This creates competing investment ideas between the individual investors and the institutions. The institutions have years if not decades of experience. Lots of research and loads of assistance. They can weather the storm as well as have people identify other opportunities to make the money back that was lost. Institutional investors rotate out of sectors. Out of stocks. Out of positions. They know the game because they invented it. That is not to say individual investors did not teach institutional ones that the world has a new paradigm in the Gamestop or AMC trades. But those are two isolated examples.
The key here is even the best algorithm trading system cannot compensate for the specific trends and economic forces. Programmed trading is only as good as what it learned last time. So going back to the internet bubble, at the cocktail party I ran out of the place where the party was and called our trading desk. I told them to set up the top five positions involved in technology or the ‘internet’ and sell it. Sell it all. Why may you ask? Well if the irrational exuberance had reached the bartenders at some catering facility, then we were all in for a rude awakening. Sure, enough we were, and the market corrected significantly several weeks to a month or so later.
Similar events are happening now whereby investors believed the viability of the stories of tech companies that were darlings. But what the gaggle of investors seems to have forgotten is that no upwardly trending market or bull run lasts forever.
There is an old market saying that states “markets often take the stairs up and the elevator down”. In case you were tired of walking, not to worry we are on the elevator right now anyway, and do not expect the elevator to stop for too long on any given floor.
Think of a downward trending market as a snowball that begins to pick up speed as it moves down. The steeper the drop the more momentum it picks up. That is the same as the individual investors that cannot afford to lose the money, either panic selling or looking for an exit. Unfortunately, the elevator has not stopped and what everyone needs to really do, is not panic. Which we realize is the opposite of the reality in people’s minds. Trust me I am living proof of it. (a story for another day)
Keep in mind though, as many value investors state it is better off not to watch the market as closely in a downward sloping trend. Why? It is because of the self-fulfilling prophecy of anxiety as you continually look at your investments and they are down sharply. You are in good company though as everyone is feeling the same. Inflation is a current issue facing the world. The current rate of inflation hit its highest level in approximately 37 years as the rate of price increases or changes in CPI rose almost nine (9%) percent year over year.
That is why the Fed is now increasing interest rates to attempt to try to stop a recession from occurring. (too late) Add to that Mr. Putin’s temper tantrum in Ukraine and the upset supply chain issues we experienced due to COVID and you have new economic issues based on issues that normally do not exist together.
Further analysis suggests that as much as we do not want to believe it, equities were extremely high before they started correcting. As interest rates increase overall value gets affected which creates downward pressure on stock prices due to profits becoming less as costs go up. For growth stocks, this becomes a larger driver of overall value, which becomes an even faster correction due to their higher vaulted valuations.
Most are hitting the anxiety ripcord since a lot of these stocks were a stable source of return over the past number of years as their growth could be quantified, or so you thought right? What happens then is we get used to the market going down. Things are being valued less and portfolios constricting. Then is not so bad anymore and equities stop going down as fast. The elevator slows and eventually stops at a floor. That is because we have reached what we commonly refer to as ‘relative value’.
Then it will go back up to a higher floor. But we recommend that you try not to hit the sell button and consider taking the stairs…..
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