It was yet another tumultuous, volatile week on Wall Street, with three major averages ending a sixth straight week of losses. Wednesday's Federal Reserve-induced rally was not met with conviction, the market sold off sharply thereafter on Thursday and Friday, with the Dow Jones Industrial Average dropping nearly 1200 points (3%), the S&P500 dropping 4%, and the Nasdaq Composite dropping 6.5% . This is after an all-in ugly month of April, with the Dow dropping 4.91%, S&P 500 dropping 8.8% and the Nasdaq Composite dropping 13.26%, worst monthly performance since the pandemic.

The Stock Market Is Priced Based On One Piece Of Paper

We think investors should get used to ugly days like these. The market has been re-pricing stocks on the fly, with Wall Street deciding all stocks are worth less anytime a thing called the 10-year treasury ticks down in price and up in yield. That's what happens in this stage of red-hot, run-away inflation. 3.5-year high on the 10-year yield crashes everything. It's been so long since we've had a market like this, that many investors think the Federal Reserve is in charge of all interest rates. It's not true. Long-term rates (the 10-year yield in this particular example), are controlled by investors around the world (selling pressure in treasury leads to lower prices, which means higher yield). Bond investors are losing fortunes owning US treasuries because of inflation. Therefore, they wanted the Federal Reserve to take a more aggressive approach to fight inflation. In other words, they wanted the Federal Reserve to engineer a recession. They wanted to hear from Chairman Powell that 0.75% rate hike was on the table, but didn't get it, after Powell decisively said "at this time we're not considering a 0.75% hike" on Wednesday. These bond sellers don't trust that the Federal Reserve can control run-away inflation with a series of 0.50% rate hikes, therefore, they sold long-term bonds, the yields tick up, and stock prices go down.

A Curious Mindset To Make Money

Although the bond market is much bigger and much more powerful than the stock market, the two have always been closely related to one another, almost joined to each other at the hip. We're stock investors, so let's talk about stocks. I'm not an economist, a financial expert or a businessman by training; I'm a scientist by training. In current pursuance of my Doctor of Philosophy Degree in Neuroscience, I am taught to always be curious, logical and never stop asking why. It is with such mindset that I bring to you my playbook to stock picking, to portfolio management, is to be curious.

First, is every company worth less today than yesterday? That's what the stock market is saying, with the relentless, brutal, wholesale sell-off in every single stock. The answer is no. If you're taking the cue only from the bond market, seems like we're heading for the world of high inflation, where the Federal Reserve will ultimately have to aggressively raise interest rates. If you believe that, you have to buy stocks of companies that benefit from a high-inflation slowdown - the Jimmy Carter scenario. Think about the oils. Our portfolio owns Devon Energy (DVN), whose breakeven price is in the $30/barrel. With crude prices staying above 100$/barrel, these guys have been practically minting money. They've promised again and again to be disciplined with drilling, and committed to returning capital to shareholders.

Second, will Russia-Ukraine conflict never end? Will China's lockdown last forever? Of course not. Yet right now, the market meltdown is reflecting a never-ending war, a never-ending lockdown. Even if China never agrees to do anything differently in their strategy to fight Covid, we know these lockdowns end after a few months. If the CCP comes to its senses and start using any of the Pfizer, Moderna, AstraZeneca vaccines, the pandemic will come to an end there, like it has for most of the world. For the Russia-Ukraine situation, right now it seems endless, but a curious person would never accept that verdict: sooner or later, one side will win and the war will end. 

Third, how permanent is inflation? The bears are worried about permanent, hot inflation. However, if you look at charts, you can see the prices of steel, copper, aluminum, grains, used cars, freight and storage are well off their highs, and look to be in a downtrend. The only commodity that doesn't seem to go down in price is oil, but we know that's because of a war, which again, will end sooner or later.

Fourth, do earnings still matter? The broader market has been behaving like earnings from companies do not mean anything. Let's take the case of Advanced Micro Devices (AMD). It recently closed on a massive acquisition - Xylinx - which analysts thought was having high single-digit percentage of revenue growth. Because of the deal, both AMD and Xylinx weren't allowed to talk. It turns out that Xylinx is growing at 20%, not high single-digit. That is called a surprise. However, AMD's stock doesn't seem to care, being ~50% down from its high. You're getting the Xylinx news for free. When you see something this good that's immediately additive to earnings, how can it not be a buy here? 

The Bottom Line

I agree that it's a disgusting, horrible market that rests entirely in the fortune of one piece of paper, the 10-year treasury. But a curious person asks if this one piece of paper can control the future of every companies in the world. Where is it written that the 10-year must go down in price, up in yield every single day? Where does it say that May's inflation number will be hotter than April? How can we be so sure that Chairman Powell won't raise interest rates as aggressive as he needs to in order to control inflation? Right now the stock market is pricing in the worst-case scenario, but I think there's a good chance that we actually don't get it. 

One more thing. Let's say you own no stocks right now, all in cash. Wouldn't you be tempted to buy something down here? If you have enough cash on the sidelines, the market is throwing a wholesale on everything, including great stocks with good yields, great prospects that are going to beat the earnings, the kinds of stocks that we own in our portfolio and you can see here.

Bottom line, it is so easy to panic. It may feel great to sell everything now, and just set your mind free. It's hard to be curious when your portfolio is being beaten. However, over the long haul, curiosity tends to be a much better bet. Right now I believe a curios mind would be buying stocks selectively, not selling them indiscriminately. Curiosity might have killed Schrodinger's cat, but it can also make you a fortune.