Is it too early to buy Growth Stocks?

11

 

I’ve not bought a single growth stock since October 2021.

I’ve bought REITs yes, but no stocks.

Since then – SEA is down 75%. Grab down 70%. Netflix down 50%.

Which got me thinking… is it finally time to start bottom fishing for growth stocks?

Or is this a falling knife?

 

Why it’s too early to buy growth stocks?

1. A repeat of 2008… with Commodities

Now for those of you who haven’t heard of him, Zoltan Pozsar is THE go-to guy for USD funding.

He’s the expert on USD plumbing, and when Zoltan speaks, people listen.

Now Zoltan thinks that this could evolve into a Lehman 2008.

The reason why is that commodities are heavily collateralised.

Put it this way – Think about the oil trader, who bought Russian oil, pledges the Russian oil as collateral to get a loan, and then uses that loan to buy more Russian oil. And so on.

What happens then, when the value of the Russian oil he holds plunges overnight?

He now has a margin call.

Not just on the first pledge, but on all the subsequent shipments of Russian oil he leveraged up to buy.

Basically, the commodities version of CDOs in 2008.

Multiply this across everybody owning Russian assets in the world, and multiply this by how opaque the modern financial system is, and you may have yourself the early stages of systemic risk.

What happened in 2008 with collateralised mortgages, may repeat today with collateralised commodities.

There are early signs of funding stress in the system.

The past week, we saw Nickel soar to $100,000 in a massive short squeeze.

We see dollar funding stress jumping to 2 year highs.

We see credit default swaps for the European banks going up.

Now of course I’m not saying that a repeat of 2008 is guaranteed.

All I’m saying is that you don’t remove a commodities player as big as Russia overnight, without the risk of something breaking in the system.

The coming weeks will be crucial to watch.

2. Feds don’t have your back… yet

The rest of the macro picture is equally gloomy.

US inflation came in at 7.9% for February, the highest in 40 years.

And remember – February is BEFORE the sanctions against Russia kicked in.

Adjust for that and you’re looking at 8-9% inflation in March.

The market is rightly freaking out about this, because the Feds cannot ease monetary policy in the face of 40 year high inflation.

The market is now pricing a whopping 7 rate hikes by Dec 2022.

And there’s nothing growth stocks hate more than rising interest rates.

When all of your earnings are far out in the future, a small rise in interest rates has a massive impact on valuations.

3. Stagflation dead ahead

The western sanctions on Russia have created a massive supply shock in global commodities.

This has driven up the price of everything across the board, from petrol to food to construction costs.

 

As consumers spend more on food and petrol, they have less money to spend elsewhere. This slows down economic growth.

At the same time, companies are hit by rising costs, as salaries and the price of raw materials goes up.

They are forced to raise prices to protect their margin.

And before you know it, you have the early stages of stagflation (slow economic growth and high inflation)

Now stagflation is one of the trickiest macro environments to be investing in.

You can’t go to cash because inflation erodes purchasing power, and you can’t go into stocks/bonds because rising interest rates will crush them.

What a disaster.

But FH… market has priced this in…

Now I get it.

Many of you tell me that the market has already priced in 7 rate hikes and stagflation.

Which means that any surprise on the upside and stocks may fly.

My simple view, is that the market cannot price this phase change so quickly.

Think about how the market went up over the past 18 months as a result of QE and earnings growth.

If things were truly priced in, why did the market not jump 50% in March 2020 and stay flat the next 18 months?

When you’re dealing with stock markets this big, it takes time for things to play out.

It takes time for the rising interest rates and tightening liquidity to feed back into the stock market. It takes time for investment committees to meet and amend asset allocations.

And valuations wise – the S&P500 trades at 18.5 times forward PE now.

If you factor in margin compression and slowing earnings growth, that’s still on the high side.

The 2018s range of 15-16 times P/E is more like it.

Which could imply another 10-15% drop in the S&P500 before this is over.

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Why buy growth stocks now?

1. Individual Stock Valuations are cheap

That said, this analysis is for the market across the board.

At an individual stock level, there are names like SEA that are down 75% from highs. Grab has crashed 70% from IPO price.

So yes, at an individual stock level, there are names that are starting to look attractive.

The problem though, is that when the market breaks, the baby is tossed out with the bathwater.

Just like how an expensive stock can get more expensive (look at the past 18 months), a cheap stock can get cheaper.

So how do we know where the bottom is?

Normally – You watch the Feds to call the bottom…

In all recent financial crisis – Lehman 2008, Oil crash 2015, Powell 2018, COVID 2020, the buying signal came from the Feds.

Basically over the past 20 years, the only thing you needed to do as an investor was to watch the US Federal Reserve.

The moment they implemented emergency moves to support markets, you just start buying.

Works every single time.

This time around though – inflation is at 40 year highs.

Unless we get a lot more pain, I frankly don’t see Powell changing the path of rate hikes, or coming in to support the market any time soon.

So then… how do we time the bottom, without the Feds?

The historical precedence is not pretty.

1930s, 1970s, Asian Financial Crisis (for Asia).

In those cases, without Fed monetary support, the market decline took years to play out.

Who can replace the Feds as a timing signal?

I’ve been thinking about this question a lot recently.

And the more I think about it, the more I think we will never get a repeat of the 1930s or 1970s.

And the reason why is that governments have discovered the power of fiscal stimulus.

In March 2020 global governments discovered that they can come in with massive public spending, to bail out the economy.

And you can’t put that genie back in the bottle.

If the pain gets really bad, governments are going to come in with massive spending.

Which means that this time around, the signal to watch may not be monetary policy from central banks. It may be fiscal policy from governments.

2. Ceasefire could cause stocks to jump..

I wish with all my heart that this war were over by tomorrow.

If we get a ceasefire between Russia and Ukraine, and the western sanctions go away, stocks could fly.

But frankly, I cannot evaluate the odds of this happening.

Much will depend on the kind of ceasefire we get. Unconditional surrender, Kyiv levelled or a war that drags on all year?

And even if we get a ceasefire, will the sanctions on Russia go away overnight?

Goldman Sachs pulling out of Russia is a worrying sign. If even Goldman is pulling out, it indicates that they don’t see a resolution any time soon.

And I’m inclined to agree.

From what I know of politicians, once something is done, it’s very hard to undo it.

Even if there is a ceasefire, don’t hold your breath on sanctions going away.

Which means the commodities supply shock, and higher prices, may be here for a while.

3. Can’t (or won’t dare) to buy the bottom

When the market is at all-time highs, everybody thinks that if there is a 20% drop, they would go all-in.

Then the 20% drop actually comes, and instead of buying, everybody is selling.

It’s one thing to talk about being Warren Buffet, and another to actually do it.

Now I don’t profess to have nerves of steel.

When the market is crashing, I too feel fear and this affects my position sizing / judgment when buying.

So because of this, I do think that sometimes it may make sense to average into a declining market, especially if you know your own psychological makeup (and fear of buying in a crash).

Do I think it is too early to buy growth stocks?

My personal view, is that it’s probably a bit on the early side to be buying growth stocks in size.

I think the macro headwinds from rising rates, high inflation, and slowing economic growth are very, very real.

And I think the S&P500 probably needs to drop another 10% or so from here to really price in the macro headwinds.

Which indicates more pain ahead.

How to call the bottom?

That said – I also think calling the bottom this year is going to be a lot harder than in 2022.

We may not get as clean a moment like March 2020 when the Feds came in with unlimited QE and the market bottomed out that day.

It may look more like 2008 or 1997 (Asian Financial Crisis) where the economic picture was a lot more murky, and it took months to establish a clear bottom.

But I do agree that certain stocks are starting to look attractive, and the difficulty of timing the bottom this cycle means that it may make sense to start buying cautiously.

But that would come down to an individual stock analysis.

Some stocks are down 70-80% from highs, and may bottom before a broader market bottom. Some like the FAANG are still very close to all time highs, and may make less sense.

What if I am wrong?

As I like to say on Financial Horse – “Forecast everything you can, and then prepare for the possibility you are completely wrong.”

What if this is indeed the bottom for growth stocks 2022?

What would need to happen for growth stocks to scream 50% from here, over the next 12 months?

Maybe Russia-Ukraine reach a ceasefire this weekend, with complete and unconditional Russian pullout of Ukraine. Western sanctions are removed by Monday. Inflation comes down over the next 3 – 6 months, and Feds only need to do 2 – 3 hikes in 2022.

Even in such an event, there would be opportunities to buy along the way.

Sure, I would miss the initial 10% move (maybe more for the illiquid small caps), but there is still time to pile on as events play out.

And as shared previously – I’ve started to buy S-REITs.

I like S-REITs because (1) valuations are attractive, (2) they may be effective inflation hedges, and (3) they do well if interest rates don’t go up as much as the market is expecting. 

In any case – I’m still holding onto the bulk of my long term positions, so I do benefit if stocks go up.

You can check out Patreon for the names I am buying and my asset allocation.

No capitulation move yet

What I would say though, is that there doesn’t feel like there is a capitulation move yet.

You know, that mad last grasp of selling where margin calls feed into margin calls, and there is blind panic in the markets.

So far, it feels like a very orderly deleveraging, with no one piling for the exits.

Could be wrong, but I still think we’ll see one of this before the bottom is in.

Closing Thoughts: Long term, tech still a buy?

That said, leaving aside the short term macro, I remain very bullish on technology longer term.

Technological growth is what drives human society forward.

Without technology, we’ll still be cavemen without fire.

Never bet against human ingenuity.

I still see lots of secular growth in technological trends like Cloud computing, Artificial Intelligence, Web 3.0, Biotech etc. The best days for humanity lie ahead, not behind.

In fact I’ll probably look to start covering more growth stocks on FH going forward.

And you can sign up to Patreon for my full stock watchlist and portfolio positioning. I’ll update it next week to share the counters that I am keen to purchase in the coming months, as 2022 plays out.

That said, I would absolutely hear what you think.

Is this the bottom for growth stocks in 2022?

Or does more pain lie ahead?

 

As always, this article is written on 11 March 2022 and will not be updated going forward. Latest thoughts (and my stock watch and personal portfolio) are available on Patreon.

 

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11 COMMENTS

  1. Hi FH, great post once again. I think the biggest risk right now to the entire economy (not markets) is sustained commodity price inflation. Even before the war, predictions for end 2022 CPI in the US were around 4%, now it’s up to around 4.5%. In Singapore, we are already feeling the heat at 4%. Even though food was only 2+% in January, a trip to NTUC tells the entire story. Of course prices can come down due to a variety of reasons, increased shale production, re-building the keystone pipeline, venezuela, iran, saudi etc. But if Putin pulls the plug, the tail risk is just too big. Therefore in the face of uncertainty, my view also is to do nothing with regards to growth stocks. No point selling now at the bottom, but very risk to add on position with such high uncertainty.

    Also, don’t fight the fed they say. Until the Fed says what level of inflation they are willing to live with, 3%? 4%? I wonder if they will stop hiking when the 2s10s spread goes to zero, or they will hike the spread into negative territory like Volcker did. And powell did say he will follow in the steps of volcker. All eyes on Powell next week.

  • I have this thought that the current bout of inflation is not your typical one. There is no unusal surge in consumer demand nor a permament depletion in supply. One disruption caused by nature and one by man combined to divert more consumer spending to certain goods (pay more but not for larger quanities) and in the process diminish spending for many others. So the economy is not over heating, instead more like many sectors will be under stress due to lower demand that may add to their problems of lower capacity utilisation caused by the disruptions to the supply chain. Not sure if a similar situation existed before and how the FED will see it.

    • Actually my view is that this inflation is caused by both a demand and supply shock.

      Supply shock from COVID and now Russian sanctions.

      Demand shock from all the fiscal and monetary stimulus, and COVID disruptions that send goods consumption through the roof.

      Nothing much can be done on supply side, but you can destroy demand by tightening monetary policy. If the Feds don’t do so, they risk losing all credibility, and in such an event, the outcome might be even worse.

  • What level of cash you’re holding?
    I am at 80% level. Watching my portofolio burning is a very painful thing. Growth stocks are bleeding dry. Death by a thousand cuts.
    I think 2022-2023 will be full of pain. Now we are at maximum fear with inflation, china slow down, war, covid, china stock crash may have a spill over effect globally as people lose money means spend less, etc. Stagflation or “lost decade “ is a real possibility. If it does come, will Fed keep pumping money like Japan to keep the economy alive? Money stuck in stocks for 10 years. Like Great Depression. Perhaps dividend investing is the way to go for now. when Fed does hike, will funds sell stocks and allocate more to bonds?

    • Definitely elevated levels of cash, but nowhere near 80% haha. Do you mean 80% of your portfolio or net worth?

      Broadly agree that 2022 (and maybe 2023) will be tough. But frankly don’t see a lost decade. If things get bad I believe governments will step in with fiscal stimulus, which should be sufficient to “solve” the problem. Don’t see an exact repeat of 1930s or 1970s imo.

  • Honestly I think we may even have a great depression (once in a century) . The time is up and due for one soon. US likes to impose lose-lose and self-defeating measures. I am very very pessimistic right now. Even if they pump another 5 trillion to bail out, the debt to GDP will soar… and USD value will be eroded. Inflation will still continue. There is really no freaking way to solve inflation… what do you think?

  • And if depression or recession comes, poor people are gonna be real mad. Inflation and covid have already made them mad. Then we may even see more protests, riots ,looting etc. although not in SG . Perhaps a black swan event is civil war? https://www.theguardian.com/world/2022/jan/04/next-us-civil-war-already-here-we-refuse-to-see-it

    More labor strikes, driving up labor and transportation costs, more inflation. Everything spiral down from here. The end of the world

    • Agree on possibility of civil war, or at the very least, further civil unrest. Ray Dalio has some very good pieces on this and how inequality is driving an ideals dividend that feeds into civil unrest. Worth the read.

      And in the shorter term, rising fuel and food prices are going to cause massive global instability. The richer countries can subsidize food/petrol, but what about emerging markets?

  • On REITs, this time around I am less confident of their ability to raise rents.

    Demand-pull inflation environments tend to be more straight forward, interest rates rising but demand booming, so REITs get to raise rents in tandem with their higher funding costs.

    Stagflation is trickier, as margins of their tenants get squeezed, so it’s not clear whether REITs will be able to raise rents as easily.

    That being said, from an asset allocation perspective, there really aren’t that many alternatives around :(.

    • No I agree. The point of buying REITs is not to make money, it’s to hedge against the possibility that I am wrong on my macro call.

      The bulk of my “trade” I suppose comes from my long cash position that will go into the market when the big decline comes (if at all).

      And with REITs I think valuations are attractive enough that I don’t see major downside from here. 10 – 15% tops is probably it, unless we get a liquidity crunch.

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