There’s an old floor trader saying that “even the pretty girls get hurt in the bus crash”.
That isn’t meant to be sexist or tasteless; what it accurately describes is that equity market corrections, eventually, take even the best companies lower in price.
Last week, I wrote to you about whether this is a “bear” or a “scare”. I told you we were in the midst of a “genuine global growth scare”, with those concerns spreading to the largest economy and equity market in the world, the United States of America.
Since that note last week, both equity and credit markets have deteriorated to the point where we are now seeing “pretty girls” sold.
This growth scare has spread to highly valued growth stocks, and there has been significant share price damage globally and locally in highly valued growth stocks.
As they say, “momentum investing is wonderful until momentum is lost”. That is just so true and there’s probably no better example of “momentum being lost” than in the so-called FANGS.
FANGS refers to the combination of Facebook, Amazon, Netflix and Google. Google is actually called Alphabet nowadays but the stock ticker remains as ‘GOOG’.
Many investors and commentators had raised concerns that US equity market breadth had narrowed sharply last year and all the heavy lifting was being done by the FANGS. That was certainly the case but now the FANGS have joined the broad US equity market correction that started mid last year.
At Aitken Investment Management, we created our own equally weighted FANG Index. I’m sure we weren’t alone in doing this but the results show from a technical and momentum based analysis that the FANG Index has broken down.
FANGS: broken uptrend
[1]Below the FANGS are the lessor known Unicorns.
What are Unicorns I hear you say?? Unicorns are described as public companies that achieved greater than US$1 billion valuations at their IPO but currently remain unprofitable.
Yes, over $1 billion market cap at IPO yet remain unprofitable today, reminding you that “hope” isn’t an investment strategy.
Goldman Sachs created a custom basket of 27 listed companies, equally weighted, to basically create a Unicorn index.
The chart is below and confirms just how much “hot air” has come out of second- and third-tier tech.
Unicorns…
[2]Until recently, this missing part of this growth scare were growth stocks correcting.
That has now commenced globally and every indicator I look at (from yield curves through to corporate debt, credit default swaps, commodities, consensus equity earnings revisions and currencies) now confirms a genuine global growth scare, where risk premium is being added back into risk assets and leading to price falls.
In the high-flying growth stocks, it would appear to be a case of “valuations don’t matter until they do”.
To put this in context, I thought I’d compile a simple chart of trailing and prospective consensus P/E ratio for a number of leading US and Australian growth stocks and share price decline from the recent peak (source: Bloomberg). This is AFTER the correction we have seen.
[3]This is far from an all-encompassing list. I am just making the point that many of these growth stocks have corrected from “very expensive” to “expensive”. On a raw P/E basis, Apple would not be included in that assessment, as it appears fairly valued.
Of course, I am NOT saying all companies were created equal and all P/E’s should be the same. Far from it, but the premium for perceived “great growth companies” vs. everyone else has never been wider, which makes them vulnerable to profit taking.
The key problem is that investors have major multi-year profits to take in these growth/momentum names. They are sitting on HUGE paper profits even at today’s lower share prices.
What causes these share prices to gap lower is the fact there is a major P/E (valuation gap) between what a growth investor and a value investor would pay for the same earnings stream. That gap is the issue and why these stocks hit “air pockets” when momentum reverses. It does remind you that “price is what you pay, value is what you get (or not)”.
What happens is a growth scare turns into a valuation scare, as investors reconsider what the appropriate multiple is to reflect growth macro risks. You can see that absolutely nothing fundamental has changed for these companies other than a view on price from investors. Investors stop worrying about upside and start worrying about downside. It’s a basic psychological response to a changed macro assumption (global growth).
What we all need to be prepared for is the market continuing to question the valuations of pretty much any stock whose chart has gone up on a 45-degree angle for the last three years. This doesn’t mean these companies should be sold. What we need to realise is they could easily fall further on no change to their earnings growth outlook. In that event there will be opportunities, but I tend to believe this global event with local ramifications has further to play out, as I wrote last week.
I expect further volatility and high levels of stock price performance divergence. What we always need to remember, and it’s damn hard some days, is it is a market of stocks, not a stock market.
In fact, just about everything has been marked down in price (ASX200 now in bear market territory -20% from recent peak) there will be stock specific opportunities to invest and make money. There should be absolutely no doubt about that.
But make no mistake — this is different to the last five years. We will need to be highly selective in where we allocate capital. We will also need to be patient and disciplined.
I realise everyone wants to be told it’s a buying opportunity. No doubt it is in the RIGHT THINGS, but if I look across what different indicators are telling me, most are flashing “orange” and some “red”, it is absolutely NOT the time to be BUYING EVERYTHING.
These indicators have flashed a bit more red than orange since last week’s note, with the key changes being deteriorating corporate credit markets, the flattening US yield curve and global collapse in long bond yields that can only confirm one thing: this global growth scare is spreading to the USA and to world equity markets.
I realise most of us are equity focused but the credit markets are what we should be watching. They continue to warn of lower growth and lower growth isn’t great for all equities.
Remain patient and disciplined.
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