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Before trading, please ensure that you fully understand the risks involved
Trading in financial markets involves significant risk of loss which can exceed deposits and may not be suitable for all investors. Before trading, please ensure that you fully understand the risks involved

Wednesday, June 22, 2022

Arabian Business - Traversing the current market chaos: Benefits of seeing the glass as half full

By Century Financial in Century in News

Arabian Business - Traversing the current...
Vijay Valecha, Special to Arabian Business June 22, 2022

The old age adage of seeing a glass as half full or half empty has found growing relevance in today’s market conditions.

Forward-looking, greedy and yet fearful as the markets have been, the YTD 30 percent drop in the US bellwether Nasdaq 100 index has created complex scenarios for equity investing.

Previously unthinkable, even some of the most conservative and slow-moving stocks like Amazon are down by 30 percent + in this year’s trade.

Moreover, the broader US SPX 500 index recently touched its 20 percent YTD loss level, implying it is in a bear market.

As the equity markets ponder the possibility of a deeper and more protracted downtrend, we look at the below key themes and opportunities.

Are we at the bottom yet?

Probably not. US adjusted pre-tax corporate profits decreased an annualized 2.3 percent from the prior quarter.

This is the highest drop in over the last two-year period. Interestingly, consumer spending, which accounts for the bulk of the GDP calculation, grew at an upward revised rate of 3.1 percent.

Looking at the significant headwinds impacting the stock prices, we have yet to see any signs of markets bottoming out.

The ongoing downside consolidation in US equity indices is indicative of markets trying to rebalance their positions and portfolio further.

The ebbs and flows in the markets are likely to continue before any outright recovery occurs.

Inflation, supply chain – sticky headwinds likely to persist

These factors have turned out to be Achilles’ heel for the markets. Previously considered transitory, inflation has now turned out to be stickier and more prolonged.

Some much so that the US Fed now sees its neutral interest rate target range beyond the 2.5 percent range.

The bull cycle in commodities and these factors have worked together to support each other. The skyrocketing inflation in the US has raised recessionary /stagflation concerns.

While the recent surveys and some hard data have pointed to the fact that inflation might have peaked, crude oil prices staying above $90 – $100 zone will keep the pressure alive on central banks to act fast.

Is the long tech theme dead?

In one aspect, the steady drop in US tech stocks can be seen as cyclical profit booking in nature.

The majority of the top names in the US Nasdaq 100 are cash-rich companies that have prioritized and monopolised innovative and unique business models.

Apple, for example, has pioneered the concept of smartphones.

Microsoft and Amazon now hold more global market share of cloud computing servers.

Alphabet’s Google search engine continues to be the dominant website that every netizen uses.

While it is true that competition has arisen for all these significant competitors, markets, in a way, are adjusting their forward price potential in the current market selloff.

The above table shows the Bloomberg coverage of the top tech stocks. While the prices have been hammered on a YTD basis, a look at the future estimates still suggests their overall valuations are intact.

Moreover, the Nasdaq LTM P/E of 25.8x is very near its 10-Year Average LTM P/E of 25.1x. This can be seen as the overall valuations correcting themselves to the broader historical average, likely implying fair value.

Are we at the peak yields yet? What are the potential opportunities?

As per the latest US Congressional Budget Office survey, the roaring inflation has likely topped out and will probably cool down to 2 percent in 2024. With the US Fed still a long mile away from reaching its neutral target range, it would be too early to call this a peak in yields.

However, the bond markets have had a worst-ever start observed since 1987. Bond ETFs, which are passively managed, saw sizeable demand towards the shorter end of the curve duration.

Bond ETFs tend to have low management fees, no loads and low transaction costs. These savings help contribute to investors keeping more of what they earn.

For instance, the iShares Short Treasury Bond ETF, which invests in US Treasury bonds that mature within one year, saw inflows of $ 7.55 billion so far this year. The ETF is down by -0.11 this year.

Similarly, other short duration ETF funds are down in less than the -0.50 percent range this year.

Compare this with long-dated corporate bond funds ( Duration: 7 + years), which have been down by more than -10 percent this year.

So while these short-dated funds will not give great returns, a further spike in yields could see more robust inflows to these funds and protect the investors’ savings.

Buy the dip or sell the rip?

Like the US Fed, the investors are also caught between a rock and a hard place. On the one hand, investors can start averaging for the most beaten-down stocks that could fall further.

But, on the other hand, should the peak inflation and yield scenario play out, this narrative in itself could cause a short to medium-term pullback even while the overall trend may remain bearish.

Instead of speculating on the next move, investors would be wise to consider looking for the healthiest bets.

As an example, looking at the above table and the recent earnings forecast, Netflix and Amazon have suffered the brunt of the decline.

These companies are now looking into cost-cutting measures and various leadership realignment initiatives.

On the brighter side, Apple and Alphabet 12 M target valuations remain unchanged. Investors would be wise to avoid any further investment in new-age startup stocks or the recent tech index qualifiers.

These stocks, like the cryptocurrencies, are likely to lag the overall market recovery curve. Markets are likely to give attention to more value-centric names than just the potential growth candidates.

Arabian Business