Dollar sign dissolves
On February 16, I wrote “Where Have All The Stock Market Bears Gone?” to explain why I had just sold everything. In it, I covered the three major issues that put the stock market at risk:
- First: Earnings growth forecasts
- Second: Stretched financial conditions
- Third: Five leading technology companies under FTC antitrust scrutiny
Disclosure: Author was fully invested in stocks until February 14, when he sold everything
So, in a backdoor way, coronavirus has put issue #1 at the top of stock investor concerns. Important: Do not expect a gentle adjustment to occur. Investors had reached the point of placing high confidence in future projections. Therefore, we can expect a three-part adjustment that will sharply reduce the prices investors are willing to pay for growth.
- First, reductions in earnings forecasts. Analysts will adjust to the new reality (and uncertainty) and extract any underlying, optimistic assumptions. (Tesla analysts, are you listening?)
- Second, a shortening of the focal point. Gone will be the valuation metrics based on 2021 estimates. The stock market “normally” looks six months out, and that means the great proportion of today’s valuation will be tied to the murkier first and second quarters of 2020, with a peek into the third quarter.
- Third, a return of appreciation for “value” stocks. You know — the dividend payers with slow, steady earnings growth that produce a slow, not-too-volatile pattern of rising stock performance. Lessened will be the willingness to buy at high price the new, exciting, yet-to-be-proven, potentially high growth company stocks of tomorrow. (Tesla investors, are you listening?)
Major stock index performance
John Tobey (StockCharts.com)
Russell 1000 Index performance
John Tobey (StockCharts.com)
Now, onto the other problems
When growth is the driver, optimism rules and other potential problems are diminished or disregarded. However, now that the stock market looks troubled, ignored issues will come to the forefront and be assigned more importance. (Nothing attracts negativity like negativity.)
The two other large concerns I described in my earlier article are examples of the worrisome items that will be discussed. However, once the dark side becomes popular, expect many other potentially negative issues to be raised.
So, are we headed into a bear market?
Okay, to answer this, I need to know if you mean the traditional definition of a bear market, composed of pessimism, worry and a general stock market decline? Or do you mean the “modern” definition of any investment, including one stock, declines 20% or more?
For the “modern” definition, the answer is, “absolutely.” There are plenty of growth stock gainers that could easily fall back the requisite 20+%.
For the “traditional” definition, the answer is, “maybe, but probably not without a real recession risk.” Because there are many companies that don’t fit the growth mold, their stocks have already underperformed and could regain investing interest as growth stocks lose it. For example, think “value” like Berkshire Hathaway, “moribund” like Exxon, “troubled” like Boeing and “junk” like anything coal.
Important: The stock market has not been in a bubble
There have been frequent warnings about the stock market being overvalued. However, the higher prices reached since last October mostly reflect the improving growth forecasts through this year and next. Except in a few cases (e.g., Tesla) stock prices were still in the reasonable, albeit higher, range.
To get into bubble territory requires a break from fundamentals and a move into basing “value” on an exciting conceptual future vision, seemingly confirmed by a rapidly rising stock that becomes viewed as “easy money.”
For this stock market, the most we can say is that investors were confident in the optimistic projections, but with stock prices still tied to fundamentals.
The bottom line
It looks like the coronavirus has infected the stock market beyond being a temporary uncertainty. The stock market’s large selloff (Friday, February 21 plus Monday, February 24) likely dented investor enthusiasm and heightened concern. As a result, growth stocks, the favored investments over the past six months, are now at risk.
In addition, if the negativity continues, it will foster more negativity, and there are real issues that have been ignored and need to be considered.
Therefore, now looks to be a good time to hold cash reserves and await a potential downturn that produces attractive buying opportunities.
So, why am I picking on Tesla?
Because it is in a bubble and due to fall, if not plummet. See “Tesla’s Failure To Reach $1000 Will Give Investors Bubble Vertigo – Time To Sell.”