Market volatility in January has continued with the Nasdaq now down in excess of 11% from its high’s, and the S&P 500 down 7.1%. Once again, the damage in the market is understated by the indices, as we are currently seeing huge numbers of stocks down 40-80% from their highs. Fortunately, value stocks have held up a lot better than the overall market, which is what you’d typically expect in a more routine selloff. Value stocks are by definition, cheap relative to the market. Historically, buying these stocks has generated the best returns over the long-term. There have been exceptions, including the last few years, when growth stocks got vastly more expensive than they had ever been except in 2000. Valuations expanded dramatically, far exceeding the actual earnings growth, which was helpful too. The spread between growth and value valuations, was the widest in history going into this downturn, so there is plenty of room for mean reversion.
Investing across a full cycle requires both seeing your money grow and holding on to it upon the inevitable bear markets that occur in a full cycle. This is why it can be perilous chasing performance irrespective of valuations, as one generally misses the biggest returns, but proceeds to get hit by the collapse. I’ll give you a few examples of the carnage we are seeing under the surface:
Peloton $PTON was one of the most glamorous stocks of 2020. The ubiquitous machines were staples in many households when gyms were closed during the pandemic. The company couldn’t keep up with demand and it had to expand manufacturing. Now as gyms are reopening, the company is finding itself with too much supply. The stock has dropped by 85% from its high of $166.57. It is now trading under $25 per share, after having dropped by 73.28% in just the last 3 months.
Beyond Meat $BYND was another glamourous company riding the wave of ESG investing. The stock topped out at $221 and now trades at $61.42. It’s down 42.65% in just the last 3 months.
Palantir Technologies $PLTR is one of the premier data plays in the market. The stock’s 52-week high was $45.00 and it now is trading for $14.62. The stock is down just under 40% in only the last 3 months.
Tesla $TSLA has been a relatively positive performer in a challenging market for Tech. The stock trades at $996, which is up 15.07% over the last 3 months. However, the stock is down just under 20% from its all-time high of $1,243.49. The market cap of Tesla is over $1 trillion and the stock trades at 154.2x forward earnings.
Stocks such as $GOOG and $FB, are not nearly as expensive as these names already mentioned. Other stocks such as $AAPL and $MSFT have really been holding the market together, along with a bit of a shift towards value stocks. We’ve seen similar strength in the largest names prior to bear markets in the past, so if those names started to breakdown, there could be a lot more downside in Tech. Overall, I still believe we are in a nearly everything bubble. Even stocks such as Coca-Cola and Procter & Gamble are trading at stratospheric valuations despite very minor growth.
There are some very attractive opportunities in foreign stocks, financials, and energy, but this doesn’t mean all the stocks in these respective arenas are good buys. J.P. Morgan and Goldman Sachs sold off hard after earnings, as the stocks have had huge rallies and are trading quite expensively at the moment at over 2x book value. In contrast, stocks like a Citigroup and BNP Paribas still trade at very material discounts to any conservative estimate of liquidation value.
We had a very positive development with Assured Guaranty $AGO and $MBI with Puerto Rico achieving approval for its restructuring plan in Title III court in relation to its generation obligation bonds. The final result should be a recovery in the 90’s, dramatically exceeding what most “experts” believed to be possible. We bought many of those bonds in the low 20’s and $AGO and $MBI have rallied nicely. There is still tremendous upside in $AGO and I don’t sense that market participants have fully grasped how significant of a development this will be to the future prospects of the business.
The other major area where we are finding value and opportunity is with options. This massive upheaval is driving up premiums to extremely attractive levels. We’ve been selling puts on fantastic companies that we would love to own at returns varying from 7-14%, despite the options being over 50% below current market prices. Compare that to junk bonds yielding between 4-4.5%, with substantial interest rate and default risk. If we get exercised on these puts, we could very well make 3-4x our money upon a recovery, as the prices would be that distressed in our estimation.
Today’s inflationary environment is a major concern for the economy and markets. It eats away the value of your cash at an accelerated rate. Higher interest rates will cause losses in bonds and fixed income markets that could last many years. Equity valuation multiples are likely to shrink. While some companies do indeed benefit, it is also paramount to buy them at undervalued prices relative to those fundamentals. That is where the discipline comes in and being willing to sell stocks when they get overvalued and if we have better opportunities. I’m very optimistic on value and I feel that the utilization of options will be more important than it has ever been for us. There is a very real chance that the market indices generate negative returns over the next 5 years or so from these elevated levels, but we can stack the odds in our favor with options. That is the tradeoff. In some really big up years, we should underperform, but in the flat to negative years, we have the potential opportunity to post vastly superior performance. If we get a value tailwind that lasts a little bit alongside that, we could really create some wealth over these next 3-5 years, and just as importantly, protect it against the Everything Bubble popping.