What a couple of days in the market, huh? While I wrote over the weekend that I expected volatility to pick up, this has greatly exceeded what I was looking for.
At this time, it makes sense to take a deep breath and try to get a firm sense of what is happening before plunging deeper into the market, or bailing out altogether. Volatility makes investors question everything that is happening…in this blog piece, I’ll try to put some context around where we are and come up with some ideas for places to make put new money that make sense on a risk/reward basis.
Is the next move sharply lower?
First off, let’s ask the question of, “is the market about to crash?” I strongly believe that this is not going to happen. There are two reasons underpinning my sense that the market is just fine. Valuations and fundamentals.
Valuations appear to be reasonable right now. It’s obviously not the cheapest stock market of my career, but it’s not the most expensive by a long stretch of the imagination. As of February 2nd, the forward P/E on the S&P 500 was around 18x. Once again, not cheap, but does that scare you? Hardly, especially in light of the growth in earnings that companies are seeing.
There are certainly excesses in some markets. For example, Bitcoin is crashing downwards now…that’s a bubble imploding. And, the bond market is looking very weak as inflation comes back and we sit at full employment. However, stocks are not in a bubble, especially the micro-caps that Tailwinds favors.
The fundamental case for stocks is also very strong right now. You’ve got a booming economy, pricing power finally coming back for companies, and interest rates still at low levels (although moving higher). Earnings for companies continue to grow rapidly and beat street expectations. Throw in great changes to the tax code and you’ve got a robust economic scenario that screams, “buy stocks!” So, based on all the good things out there, I’m suggesting we are not about to see down 20% in the next few weeks.
Is the next move sharply higher?
Just because I’m not calling for a major selloff soon, don’t think that I believe you should be running out and margining up your account for the great bull market that started with today’s reversal. For all the good out there, there are a number of areas of concern that temper my enthusiasm.
My primary area of concern is beyond the market. We are at a point in the economic cycle where interest rates are going higher. Meanwhile, there is not much “value” to be found. When you look at the triumvirate of stocks, bonds and real estate (the three biggest investment areas), everything has been in a bull market for years.
Well, the bull market is over for bonds. This is due to the Fed entering a tapering period which means that the days of cheap money are over and short term rates are going higher. This is resulting in the end of a 30+ year bond bull market.
And, despite the strong fundamentals of the economy, higher interest rates will likely offset this in the real estate market. Not calling for crash again, but saying the days of easy money are over here as well.
If I’m correct, and both the bond market and real estate market pause (or retreat), it’s tough to make a compelling case for a very strong stock market taking stocks up to crazy valuations.
No, I think the next move in the market is a consolidation period. I’m calling for a trendless market that chews up time and has a ton of volatility. A market that tries your patience and is full of false breakouts and downward head-fakes.
Stay the Course
I get questions all the time about what are my favorite stocks or “favorite stocks”. Frankly, I favor having a portfolio of stocks. At any given time, I’m hopefully making money in some stock; and it’s often in the one I least expected to rally. Therefore, I don’t have top picks, but a portfolio of (what I consider to be) great ideas, each of which stands a good chance of being a big winner for the next 6 months and beyond.
I think the market is proving out the benefits this strategy in real time. The S&P 500 is down 3.46% for the year, and, more applicably to Tailwinds, the Russell 2000 is down 1.8% and the LD Micro Index is down 4.2%. Meanwhile the Tailwinds Select Portfolio is holding on to double digit gains (+11%).
When you look at the individual components of the Portfolio, and their individual returns, there have been some outstanding stocks. Which is, of course, a further confirmation of both the value inherent in micro caps relative to their larger brethren, and the exciting possibilities that lie in front of disruptive companies.
* An aside here…while I love all the stocks in the Tailwinds Select Portfolio, there is one exception. I don’t think anyone should be looking to buy AQMS and I’ll be looking for my opportunity to exit this name sometime after they announce production starting.
In my opinion, the Tailwinds Select Portfolio is well positioned to outperform the market based on the fundamental strength in each of these growing companies. It’s certainly a high-beta portfolio, which means it should have more volatility than the overall market. But, as the performance has shown since inception, and more so recently, it’s a high-alpha portfolio; this means it is outperforming the broader indexes.
It’s easy to outperform by buying aggressive (high-beta) stocks in a rising market. However, there is usually risk in that strategy; when the market turns, you underperform. Outperforming in a down market while owning smaller, less liquid, growth stocks such as we have in the Tailwinds Select Portfolio is a very difficult thing to do.
I’m pleased with our performance since inception; but most pleased with how we’ve done the last few weeks. Up 11% in the face of a down market is, frankly, amazing performance that exceeds my expectations.
That being said, some investors prefer to pick and choose their entry points into stocks and trade around positions. With the volatility in the market, perhaps some of the Tailwinds stocks have been hit harder than others, representing a more compelling near-term opportunity? A chance to rebalance within the portfolio?
I ran a screen of all the companies in the Tailwinds Select Portfolio to see which ones have been hit the hardest since the first of the year. All Tailwinds stocks should be ripe for an immediate bounce back to their prior levels on any good news; the hardest hit would, thusly, have the most upside just to return to prior levels. Here’s the list.
As you can see, this portfolio doesn’t look like it’s been in a down market. More than half the stocks are up, with some putting in tremendous YTD returns. Yet, there are some stocks that are down a ton despite no negative news. These could be considered ripe for a rebound when the selling pressure subsides.
* As a further aside, and to reinforce my point favoring a portfolio approach, had you asked me to only own one stock at this time last year, it would have been AQMS…which has gone straight down and I would have been doubly bummed as I’d have missed out on stocks like FSNN, which was not my “favorite” and went up 150% in a two day stretch.
I certainly love RESN, NDRA and CDXC, the three stocks (not named AQMS) that have been hit the hardest since December. All three have excellent prospects and you can make a value case for them based on their growth prospects. I’d also be hard pressed to think that the next piece of news out of these companies will disappoint; their fundamentals are excellent.
If buying the weakest stock, the most oversold ones in my universe, fits your strategy, those three are Tailwind’s top losers year to date. I do, of course, recommend a portfolio approach to investing. But, based on this simple screen, perhaps these should be the first names on your shopping list???
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