The Corrections Have Come
Who Has Been Most Impacted and What Effect Could it Have on Jobs and Economy?
January for stocks was a bloodbath. Following fears that a hawkish Fed could bring as many as 4 rate hikes this year, the Nasdaq plummeted deep into correction territory, while the S&P 500 also flirted with a correction. The Fed’s back is against the wall as it confronts the U.S.’s worst inflation in 40 years.
Both indices saw their worst months since March 2020. In fact, if the Nasdaq didn’t have two days of gains in a row to end off the month, it would’ve been its worst January on record.
Although February has started with winning streaks for the indices, the reality is settling in. Beyond rising rates, the pandemic is still here, as are supply chain bottlenecks, a global shortage in chips, soaring energy costs, and a Russia that seems hell-bent on stirring up trouble.
Stocks are also sharply down again after Facebook parent company Meta (FB) reported disappointing earnings saw its shares tumble over 25%, sending the Nasdaq down another 2+% in the process.
In times like this, diversification is critical. There are certainly a lot of headwinds for both the economy and the stock market right now. You can make the case that the stock bubble market may have popped for highly valued tech names, pandemic-era winning stocks, and cryptocurrencies.
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When it was at its all-time high, the Nasdaq had a historically high forward price-to-earnings (P/E) ratio of about 35x. Although it’s since fallen to roughly 27x, we’re still discussing an index well above its pre-pandemic average of 24x.
If there’s one index most sensitive to the Fed’s monetary tightening, it’s the Nasdaq. When rates rise, the cost of borrowing increases. We saw the Nasdaq get spooked in 2021 whenever the 10-year yield would rally, for example.
Now that the Fed is more aggressively reducing its balance sheet and removing liquidity from the system, the balance sheets and cash flow statements for many high-growth tech plays start looking a little less attractive and even more overvalued.
In January, the Nasdaq 100 saw deep red. Only 18 out of 100 stocks in the index gained while 9 ended tanked over 20%.
Source: Yahoo! Finance
We may be at or around the bottom. The general consensus is that the Fed could hike rates 4 times this year, and JP Morgan’s legendary CEO Jamie Dimon believes this could be priced in. Wedbush analyst Dan Ives also called tech stocks “way oversold on Fed fears.”
On the other hand, downside pressures could likely persist.
First of all, nobody truly knows how hawkish the Fed could get. Bank of America cautioned that we could see up to 7 rate hikes. We could even see rates rise a dreaded 0.50% in one fell swoop, as Atlanta Fed President Raphael Bostic warned until things get under control.
Additionally, not every tech company is Apple that can withstand supply chain and economic shocks.
While buying the dip, especially in the recent past, has proven to be a successful strategy, especially for the long-term, these current economic risks are arguably more concerning than the coronavirus risks from back in 2020. Instead of a sudden shock to the market, this could be a much more drawn-out and volatile downturn.
Typically, as January goes, so does the year. As LPL Financial chief market strategist Ryan Detrick notes, poor January performance generally is followed by more poor performances in February.
“We are encouraged by the big reversal in stocks last week and we think stocks are in the process of forming a meaningful bottom,” Detrick said in a note. “But the truth is, this year is going to be much more volatile than last year and investors had better buckle up their seat belts if the first month is any indication.”
Pandemic Winning Stocks
Many of the hottest stocks that caught fire during the pandemic’s lockdown era are facing dual headwinds. These high-growth companies can no longer take full advantage of 0% interest rates or people staying at home and living their lives remotely.
Fortunes have changed drastically, and many of these companies need to pivot to a “normal world,” where growth capital isn’t free, and people are leaving their living rooms.
Several of these stocks that once flew at sky-high valuations began falling off a cliff in the last quarter of 2021. Year-to-date has brought more pain and chaos. Consider what some of these stocks have done over the previous few weeks.
Netflix was bludgeoned after missing growth forecasts, notably on new subscribers for Q4 2021. It dropped nearly 20% in one day and almost 30% year-to-date.
Paypal & Shopify
PayPal and Shopify were both pandemic darlings. Shopify, in 2020 alone, saw its revenue grow by 86% and gross merchandise volume increase by 96%. Yet after PayPal reported disappointing earnings, Shopify’s stock plummeted 9.5% while PayPal had lost nearly a quarter of its value. Both stocks are down over 30% year-to-date.
Peloton is the epitome of a pandemic winner that has been unable to properly scale and pivot its business. It’s off a stunning 85% from its all-time highs reached 13 months ago and has faced numerous controversies.
Supply chain woes have caused delivery delays and last-minute cancellations. Internal docs showed it slashed 2022 sales goals for its apparel unit after seeing revenue more than double a year ago. There were also leaks that Peloton planned to pause Bike production from February to March to cut costs.
They need to. Peloton burned through $639 million in free cash flow during Q3 2021, despite having only $924 million in cash and short-term investments. Perhaps that’s why they had to sell $1 billion worth of stock in November. Does this sound like a well-run company?
These are only three examples. Other pandemic-winning stocks have plunged, too, such as Moderna, Robinhood, Block, and more.
You could try to start bottom-feeding, but at this point, speculative plays that once won in a different might be like catching a falling knife. These stocks were overvalued and still largely remain so, especially when confronted with the prospects of higher rates.
In keeping with the theme of the Super Bowl approaching, let’s discuss LA Rams polarizing superstar WR Odell Beckham Jr.
Beckham Jr. left a horrible situation in Cleveland and signed with the Rams mid-season. Being the eccentric fellow he is, he opted to take his entire NFL salary in Bitcoin. Remember, this was around November. Crypto was scorching hot, and Bitcoin hovered around all-time highs at $68,000.
Beckham’s contract in USD when he signed was worth roughly $750,000. Do the math. Bitcoin’s value, as of Feb 3, 2022, was around $37,000. This NFL star WR is about to play a prominent role in the Super Bowl for a contract that’s value dipped from $750,000 to little more than $413,000.
That’s crypto for you.
Early 2022 has been a completely different ball game for all aspects of the cryptocurrency sector. Beyond just different cryptocurrencies, we’ve seen concerns in other segments, namely NFTs and DeFi protocols.
The world sees how truly risky these assets are in times like today. Crypto is highly deregulated outside and can perform like a speculative slot machine. Crypto can also be exposed to severe hacks and illicit behaviors in turbulent times.
On the other hand, with more mainstream crypto becomes, the more mainstream risks it’s exposed to.
“The [crypto] pullback highlights that bitcoin (BTC-USD) and other cryptocurrencies are becoming more correlated with conventional financial market variables,” said Zach Pandl at Goldman Sachs a week ago.
“Over time, further development of blockchain technology may provide a secular tailwind to valuations for certain digital assets. But these assets will not be immune to macroeconomic forces, including central bank monetary tightening,” Pandl added.
Consider how far crypto has fallen alongside other high growth and speculative tech plays.
- Crypto saw a record market cap of $3 trillion in November 2021. January bloodbath wiped out $500 billion from this.
- DeFi Protocols saw total value locked in (TVL) surge from about $26 billion to a peak of $112 billion on Nov 8. Since its November peak, DeFi’s TVL has plunged over 29% to $79.17 billion.
Source: DeFi Pulse
Crypto and blockchain technology still do have a bright future. Especially assets like stablecoins which more and more financial institutions appear to be looking into. As a stronger dollar could come from the Fed’s monetary tightening, stablecoins could benefit as they often have fixed value attached to the currency.
Crypto also remains a very speculative asset generating a good deal of interest that can rally at a moment’s notice. NFT sales, for one, jumped in January.
There still, however, could be more room to fall for the space over the next few months. For one, analyst Benjamin Cowen believes that $30,000 could be the bottom for bitcoin, and a “full-on worst-case scenario” could put it at around $20,000.
Especially as countries continue cracking down on mining operations, instances of fraud continue occurring, and energy prices continue soaring.
It’s definitely a questionable place to be at the moment.
The Jobs Market
The Nasdaq and other speculative plays don’t necessarily correlate with jobs and the overall economy. But inflation and the Fed’s policy touches everyone.
We also still cannot underestimate COVID’s impact.
The U.S. ended off January with rose-colored glasses, with stocks gaining and the announcement that 2021 saw its fastest annual GDP growth since 1984.
February is barely a week old, and we’ve seen some notable cracks in the economy and labor market beyond just historically high inflation.
The latest ISM (Institute for Supply Management) survey showed that U.S. service activity dropped to its lowest level in 11-months. Furthermore, the ISM reported its measure of national manufacturing activity fell to a 14-month low in January. The latest ADP National Employment report also showed private payrolls plunged by over 300,000 last month, its first decline since December 2020.
The Biden administration is also allegedly “lowering expectations” for December’s jobs numbers.
We will see how the economy and labor market continue to trudge through these unique times. Jobless claims continue to trend lower, showing that there is definitely a labor demand. Yet another 4.3 million people quit their jobs in December, showing how truly unpredictable and imbalanced the labor market as a whole is right now.
The hope is that labor demand continues to outweigh economic concerns. But we still have a very long way to go, with unpredictable twists and turns.
One sector that has significantly benefitted from the current conditions is energy. After all, the S&P’s top January 9 gainers were energy stocks.
WTI Crude has also broken past $88, while U.S. oil prices topped $90 a barrel for the first time since 2014. Meanwhile, Shell and ConocoPhillips crushed earnings estimates amid a ‘monumentally bullish shift‘ for oil prices.
With inflationary pressures continuing, coupled with Russia-Ukraine fears, this may only be the beginning of energy’s rally. If one false move is made, Russia could choke off Europe’s energy supply at the snap of a finger and swell global prices. After all, they are responsible for ⅓ of the continent’s natural gas supply.
Watch out for the ripple effects reaching far beyond Europe. U.K. energy bills are projected to rise by over 50% in April, and we’re starting to see some similar trends in the U.S. too.
The Bigger Picture Still Remains Solid
It’s anyone’s guess where we go from here. Concerning signs are mounting for specific sectors falling deeper into correction territory and starting a new bear market.
However, some optimistic signals show we might not be there just yet.
For one, as previously mentioned, 4 rate hikes may have been priced in already.
2022 is also a midterm election year, and during midterm years, stocks traditionally bottom out in Q2 or Q3. According to Jeff Hirsch from The Stock Trader’s Almanac, January’s declines were so steep that they exceeded the midterm average low.
Economically, we could also be mid-cycle with a potential recession not coming well until 2023. While gains this year will likely be more muted and harder to come by, the backdrop is not so bad.
There are real concerns, and nothing is perfect right now by a long shot. Nobody can predict the future, either. Yet there are probably more opportunities than you realize in this market.
It’s a different landscape than the past few years. Overvalued, volatile plays, like tech or crypto, do not look as sexy anymore.
In addition to energy stocks, value-based cyclical sectors, like real estate, financials, industrials, and materials, look awfully attractive right now.
Traditionally, these asset classes perform well during economic conditions like this. Commodities are a great place to look as well.
The key is to take a holistic approach, not panic, and genuinely do your homework. Scared money doesn’t make money. Smart money does.