What a terrible month for the equity markets. As I write this, the Nasdaq looks set to close down 12.% for April, which is its worst monthly performance since October of 2008, which was when we were seeing some of the worst developments of the Financial Crisis. The index is now down more than 23% from its high. The S&P is down 7%, which is the worst since March of 2020. It is astonishing how many glamour stocks that were the envy of the market the last two years, have given up all of their gains. It is common for stocks to be down 50-80% from their highs, which is nuts, but not unlike what we saw when the Tech Bubble crashed. It really goes to show that the price you pay really matters. In the era of meme stocks and chasing performance, valuations seemed insignificant to many market participants and we saw the most expensive stocks getting more expensive, while the cheapest stocks got cheaper, which is not normally how it goes. Now we are seeing the flip side of that trend.
Clearly the war in Ukraine and rampant inflation are major headwinds to the market. 1st quarter GDP was actually negative, surprising the market, although it should be mentioned that this was off a strong prior year comparable. With that said, this was unexpected, and it’s clear the economy is weaker than you’d imagine with unemployment so low and wages growing. Consumers are feeling the pinch of higher prices and the supply chain is getting further hammered by the Chinese dystopian lockdowns.
With all of these negatives laid out, there is still reason for optimism. Many stocks have gotten quite attractive, although I still believe there is considerable downside potential on the indices. Today for instance Amazon is down 15%, which is crushing the Nasdaq, and you can get a feel for just how big on impact some of these highly-weighted stocks can have. Apple, Microsoft and Tesla are three of the biggest stocks in the indices, and they all have ample downside potential in my opinion. They are amazing businesses, but the valuation multiples are double what they were just a couple of years ago, so mean reversion would likely not be kind to them or the indices, which they dominate.
Other stocks such as Facebook, Google, PayPal and heck even Netflix have gotten far more attractive than they have been in years! Before Facebook reported earnings this week, the stock was trading at 12.5 times earnings, for one of the highest return on invested capital businesses in the world, that is still growing. This is insane. To put it into perspective, the market is pricing Facebook/Instagram/WhatsApp as though it is Blackberry. We sold a good chunk of our Facebook above $300 per share, but have been selling puts at various levels, mostly below $175, and we feel very excited about them. We’d be happy to own more stock at those levels and we collected very substantial premiums.
Financial stocks such as Citigroup, Bank of America and LendingClub have reported outstanding quarters. All are making a ton of money and trade at non-demanding valuations. LendingClub is interesting because we don’t actually own any stock in it, but have sold cash-secured put options. The stock traded at a 52-week high of $49.21, but has now come down to $15.30. We’ve sold puts mostly at $10 and $8, with our highest being $13. These puts are going for premiums that will generate mid-teens % target profits on average, as long as the stock stays above our strike prices, well below current market value. Their earnings are rocketing, so if we owned the stock at those prices, we’d feel like it could easily double or triple over the next 2-3 years. We’ve been selling puts way out of the money because we were worried about the overall market and when you see massive selloffs like we are in, it drags the good with the bad.
If you are an investor with a one year or more time horizon, I believe there are fantastic opportunities. Barring a horrendous development such as a nuclear detonation, or a true WW3, there is the potential to make a ton of money right now. Mr. Market is a psychological basket case. For most of the last decade, he has been happy to pay rich prices and has been enormously optimistic. Right now, he is scared of everything and fearing the sun won’t rise tomorrow. The best buys are made when things look bleakest and while I’m not calling for a bottom by any means, I do believe that we are in a very fertile time for planting seeds that should blossom very nicely. There will be a day when this costly war will be over, the supply chains will improve, and Mr. Market will once again become more of an optimist. Hopefully at that point, we can sell some of the stuff that he is selling for fractions of intrinsic value now, to him then for a very healthy profit.