Thursday, 2 Dec 2021 Market Notes: Putting Price Actions Into Context

Thursday, 2 Dec 2021 8:00 AM EST

Stock market in recent days has been very volatile, driven by lots of things happening economically, scientifically and politically. With a long-term investing hat on, we love the volatility and want to use the market pullbacks to improve our cost basis in positions that we believe fit with the economic narrative in the next 6-12 months (well, that would be all of our stocks). As a result, in this morning's post, we want to put together core actions that have been driving the market and where we see opportunities. Let's take a chronological approach, starting with Thanksgiving day last week.

Omicron Variant On The Thanksgiving Table

Thursday night last week, we received news of a very contagious, potentially vaccine and treatment-resistant (data awaiting) Coronavirus variant named Omicron. This drove the Dow Jones down 900 points on Friday (-2.5%), the S&P 500 down 106 points (2.3%), Nasdaq down 353 points (2.2%). We explained in our weekly round-up that this was a shoot-first, ask-questions later phenomenon on a thin volume trading day (Black Friday, day after Thanksgiving when a lot of investors are not participating, including ourselves). 

What the variant means for the market is this will slow down the economy. Travel restrictions will occur throughout the world to prevent the spread of this variant, directly hurting airlines, travel and leisure stocks (think Disney in our portfolio). This will also cause supply chain disruptions, eventually hitting retails, consumer stocks (think Ford in our portfolio). Worries about the variant will delay return to work, more people afraid of going to work, affecting manufacturing activities (think Nucor). Moreover, slowdowns of the economy will hurt the financials. 

What the economic slowdown means for the other part of our portfolio -- the technology/growth names is actually positive. Salesforce (CRM) doesn't care that the economy is slowing down, because businesses (Salesforce's clients) will still migrate to their software products as part of a mass digitization effort. Microsoft (MSFT) doesn't care that the economy is slowing down, because who else has operating software for computers? Well, Apple's iOS, which we own too (AAPL). Advanced Micro Devices (AMD), who doesn't need chips?

Monday Relief Turnaround   

On Monday, we got a relief rally as the indices were in oversold conditions. While all major indices were up, we saw the Nasdaq tech-heavy index up the most with growth stocks leading the way, while the Dow Jones Industrial (with industrial stocks) were only up fractionally. This made sense, as scares of slower economic growth due to Covid slowdowns would make investors fear industrial/recovery stocks, while liking secular growth technology stocks. This price action was very consistent with our view in the paragraph above.

Tuesday Resumed Sell-Off: Hawkisk Federal Reserve

Tuesday we got a different tune, driven by Federal Reserve Chairman Jerome Powell's testimony in front of Congress. Powell said will discuss acceleration of tapering to deal with inflation. He also said to retire the term "transitory" for inflation. To the market, this shows that Powell recognizes inflation is a stickier problem than he thought it would be, the Fed is now behind the curve on inflation and needs to start chasing it now. Growth stocks got hit extremely bad, because inflation and potentially rate hikes to combat inflation will eat into the profits of stocks that are valued based on future earnings. Cyclical/ industrial stocks also got hit, because there are worries of the Fed removing stimulus into an economic slowdown. 

Wednesday's Whipsaw

Starting Wednesday, we were yet into another oversold condition, and a relief rally in the market was expected. Indeed this was what we got, but it was very short-lived. Early in the afternoon, we got news of the first Omicron variant in America. This sent the stock market into another mass sell-off, as we reversed the ~1% intraday gain to end with a ~1% loss at end of day. 

We think this sell-off is a buying opportunity, because this news about Omicron in America is not substantial; when we heard about the existence of Omicron, it was only a matter of time before it arrives here. People selling stocks on this news does not make sense, and we think investors should not worry.

At this point, we market has priced in most of the negative news now that we've had a 5% sell-off. We have heard about Omicron, market has sold off on it. We've heard that Fed may abruptly end tapering sooner than expected, and we've sold off on it. However, there are 2 risks that we think could still cause some pain ahead:

i) How effective is the vaccine towards Omicron? We have heard from scientists that current vaccines will be LESS effective towards Omicron, but we haven't seen the data of HOW MUCH LESS effective. Is it a 5% decline of effectiveness, or is it a 50% decline? If we get the data that vaccines will be much less effective towards Omicron, we might see some market pain associated. However, that will be another buying opportunity, because after so many variants we can trust the scientists at Pfizer and Moderna that they have the solution to deal with variants.

ii) When will the Federal Reserve raise interest rates? We have heard from Powell that FOMC will discuss acceleration of tapering at the December meeting. We haven't heard from him how fast. So that's regarding tapering. Remember, tapering opens the door to raising interest rates (increasing the cost of money, considered as tapping brakes on the economy). That doesn't mean the Fed will have to raise interest rates immediately. We also don't know how fast and aggressive the rate hikes will occur. In the coming days we will write about what the market is currently pricing.

Bottom line, it's easy to say "buy high, sell low" but if one knows how low is "low" and how high is "high", everyone would be rich. Here, we're not trying to pick-the-bottom or call-the-top on the market, but rather, we are trying to value the market based on fundamentals. We come up with reasons why the stock market is moving the way it does, and we pull the trigger when we think the price is right. For example, if we think the sell off is not based on strong merits or have been oversold, we do some buying. On the other hand, if we think the move up is not based on strong fundamentals or have been overbought, we do some selling. We do all of these active management activities with a long-term investing horizon, not a trading perspective.