The stock market has been slipping for months. It started with high-growth, unprofitable tech stock late last year as investors’ patience for growth without profits ran out. In recent weeks the outlook worsened and the contagion spread to companies with solid earnings and healthy cash flows.
Fears of what the economy and markets will look like without unlimited FED support, slowing growth, higher interest rates, and sticky inflation have built a wall of uncertainty that investors can no longer climb.
The S&P 500 tethered on the brink of correction territory mid-week and is currently down over 15% YTD, a bitter pill to swallow for many investors.
Still, these losses pale in comparison to the earth-shattering declines that some of the more speculative sides of the market are currently experiencing.
The NASDAQ Composite
The tech-led NASDAQ index is down over 25% in 2022.
NASDAQ Composite Continues to Slip
Source: Yahoo Finance
Financials, consumer staples, and utilities have helped slow the decline in the S&P 500, but the NASDAQ has been in free fall as the tech names continue to be the hardest hit.
The Russell 3000 Index is made up of 2,750 stocks. The index itself is down 18% from all-time highs. But that only tells half the story.
Russell 3000 stocks from all-time highs
Source: A Wealth of Common Sense Almost 10% of the companies within the index are down 90% or more from their highs. I repeat 90%. Pandemic darlings such as Peloton, Carvana and Redfin have been decimated.
These names will need to see a 1000% return to reach previous highs.
Nearly 1 in 2 stocks are down 50% from their all-time highs.
Major indexes may be referencing losses in correction territory, but for any investors holding these individual names, it’s beginning to feel like the Great Depression.
High Flying Funds
ARKK, once the highest-flying tech fund on wall street, has come crashing down to earth, falling over 70% from its highs.
ARK Innovation ETF Slumps from 2021 Highs
ARKK is not alone. The average drawdown for funds that gained 100% in 2020 is 57.8% as of last week. The pandemic gains have been well and truly wiped out.
Nothing lasts forever.
Crypto and NFT’s
Lastly, spare a thought for those taking maximum risk; NFT and Altcoin traders are getting their faces ripped off as we speak.
None more so than crypto entrepreneur Sina Estavi whose recent attempt to sell the NFT of Jack Dorsey’s First Ever Tweet for $50 Million highlighted the speed at which prices and perceived value can change within the space. Estavi had purchased the NFT for $2.9 million a year previous, but the auction closed with just seven bids ranging from $6 to $277.
Elsewhere in Crypto, we have seen widespread losses, with bitcoin just above $30,000 and set for a record losing streak after the collapse of TerraUSD, a so-called stable coin, rippled through cryptocurrency markets.
Terra to USD Price Chart
Source: CoinMarketCap Since November, selling has roughly halved the global market value of cryptocurrencies, but the drawdown has turned to panic in recent sessions with the squeeze on stable coins.
The worst may be yet to come.
Speculation vs Investing
But didn’t we all know this was going to happen?
Didn’t the incessant and illogical rise of these speculative Crypto and Tech positions have to end in tears eventually?
The simple answer is yes.
But the ‘when’ and ‘how’ were always unknown.
When everyone is playing and winning, it’s easy to convince yourself that you can play and win as well. It’s hard to imagine the music stopping when it has been playing for so long.
People do crazy, illogical things all the time, even when they know better. This isn’t the first time that greed pushed investors towards self-destruction, and it certainly won’t be the last.
This article isn’t intended as a snide rebuke of the investors who hold these positions. Many of those currently watching their trading accounts crater also made phenomenal gains in 2020 and 2021.
This is merely a cautionary tale highlighting that markets are cyclical, investment strategies come in and out of favour, and nothing lasts forever.
Most importantly, always know the difference between speculating and investing.
As humans, we are drawn to speculation. We buy lotto tickets not based on probability but on hope. You can ignore the statistical improbability of winning by uttering four naïve but equally alluring words:
‘Ya, but what if?’
After all, technically speaking, ‘it could be you.’
In recent years, many people ‘invested’ in their stock positions based on the same rationale. It wasn’t based on the company’s solid fundamentals or attractive free cash flows; it was determined purely on the basis of ‘what if?’. What if it continues going up? What if it doubles again? Let’s face it, for many; this argument can be far more enticing than any precise financial projections.
There is nothing technically wrong with this speculative approach, provided you realise you’re doing it, and it is done in small doses. Still, you need to separate this from your investing portfolio. They’re not the same thing.
Make sure you know the difference.
More Painful Than Ever
For most investors holding a balanced portfolio, this time is more painful than previous corrections they have lived through as stocks and bonds continue to fall together. Typically, bonds will function as a flight-to-safety in times of uncertainty, but this time around, interest rates continue to rise despite the turmoil elsewhere.
This has been a historically bad year for bonds. In fact, the Bloomberg Aggregate Bond index is currently down over three times more than any year on record.
The worst year prior to this was a mere -2.9% drop in 1994.
Bloomberg Aggregate Bond Index Annual Returns: 1976-2022
Source: A Wealth of Common Sense
The Silver Lining
Stocks are getting cheaper.
While it may be of little conciliation to those watching their portfolios dive into the red, the market over-exuberance is being washed out, and markets are now cheaper, providing a more attractive price of entry.
Small and mid-cap stocks are now cheaper than they were during the 2018 bear market and approaching the levels of March 2020 based on forward PE ratios.
Nobody wants to catch a falling knife, and these names could fall deeper still.
Waiting until you see higher lows across these names before making a move would be advised.
So, What’s Next?
Will higher interest rates and decades-high inflation tip the economy into recession? In short, inflation numbers will drive everything.
The good news is, we are starting to see signs of peak inflation.
Has Inflation Peaked?
Source: CoinDesk If we begin to see a sustained reduction in the rate of inflation, then the need for aggressive action from the FED will be tempered, reducing the probability of a policy misstep, giving equities room to breathe.
With that said, if inflation fears remain elevated, then a continuation of the current tightening cycle could result in even more pain for Equity and Bond markets.
Unfortunately, there is no crystal ball here, but volatility will remain with the potential for things to get worse before they get better as we move towards the next FOMC meeting in mid-June.
There is a lot of noise in the markets at the moment, so it is important to focus on your long-term investing plan.
90% of your assets should be positioned to generate returns over the long term. Your focus should not be on betting it all on a low probability outcome with the outside promise of winning it big through speculation.
This seems obvious, but many convince themselves they are investing based on probability and risk-adjusted returns when they are simply just closing their eyes, crossing their fingers and spinning the wheel.
Instead, focus on creating a balanced and diversified portfolio of equities, real estate, commodities and alternatives based on your view of the world in the future, your time horizon and your risk tolerance.
Invest in names you believe will be successful over the long run based on both future growth prospects and current fundamentals. From there, allow enough margin for error through diversification to protect when you are wrong.
And you will be wrong. But that’s ok. You just need to be right more often than you are wrong.