For Investors, the Shoe Has Dropped

Written by Rob Copeland | 20 May 2022

The stock market has looked at higher inflation and rising interest rates, and to say that it doesn't like what it sees would be an understatement. Since the beginning of the year, the S&P 500 index is down 18%, while the Nasdaq Composite is off by a stomach-churning 27%. The Dow Jones Industrial Average looks "good" by comparison—it's only given up 14.5%.

After years of the markets flying high, the plunge has been fast and hard. But that's typical of how rising markets transition to falling ones—and vice versa. The change in direction, whether it's a shift upward like we saw in the Spring of 2020, or a shift downward like we're experiencing now, tends to be dramatic.

In the current selloff, less-profitable companies and those built on stories about long-term potential were hit first and hardest. Zillow and Zoom are examples. By comparison, "boring" companies with solid earnings and dividends, while they may have lost ground, have held up comparatively better.

A few of my clients have asked me whether it would be wise to sell all their investments and get back into the market after the selloff is over. And the answer, frankly, is that it's a terrible idea. Selling investments now means turning paper losses into real losses. And almost no one can foresee when the market will bottom and start rising again.

Trying to guess is a fool's game. If you're late you're very likely to miss out on a big part of the gains that a rebounding market delivers. Remember—the market changes directions sharply. When a real rebound occurs—not like the head fakes we've seen throughout the year—those who are exposed to the market could very well see front-loaded gains. The first few months of a market upturn can be as profitable for investors as the next few years. In other words, you want to be sure to be in the market when the turn occurs.

My advice to investors right now is to patiently hold quality companies with good current earnings. Those paying a dividend, and even increasing their dividend, are certainly attractive. Think companies that are very likely to still be around in 10 or 15 years rather than "hot" companies that could prove to be shooting stars.

And in the meantime, watch for factors that could act as catalysts to reverse the market's direction. Signs that inflation is cooling could definitely move the market. Stronger corporate earnings, or reports that CEOs are turning bullish on the economy could also touch off a recovery.

We're telling clients to keep their cash ready and be prepared to put it to work when we see signs that a market turnaround has started. As always, don't hesitate to reach out to us if you'd like to discuss your investment portfolio.

What the Crashes of Netflix and Facebook Tell Us

Written by Rob Copeland | 27 April 2022

Netflix and Facebook were two powerhouse stocks during the pandemic, rising 100% and 38% respectively between early 2020 and the Fall of 2021. But in recent months, each has fallen hard: As of April 22, Netflix had crashed 69% from its highs, and Meta (as Facebook's parent is now called) had plunged 34%.

These two stocks' fall should be a wakeup call, if any were still needed, for long-term investors: When high-momentum growth stocks fall out of favor with investors, they can sell off dramatically. Portfolios must be built to withstand changing market conditions and the volatility that often characterizes high-flying stocks.

The reasons for the fall of Netflix and Facebook—now called Meta-have to do with their growth prospects against a backdrop of rising interest rates. To help tame surging inflation, the Federal Reserve in March raised the benchmark federal funds rate for the first time since 2018; Wall Street expects the central bank to continue raising rates aggressively through this year and perhaps beyond. Rising interest rates are bad for growth stocks, a category that includes Netflix and Meta, whose valuations are predicated on robust future earnings.

Because growth companies are more dependent on borrowing, higher interest rates cut deeper into their earnings. Inflation also weakens the value of each dollar of future earnings, another turnoff for investors. But what really concerns investors in the cases of Meta and Netflix are dimming prospects for the companies' revenue growth.

Netflix lost subscribers for the first time in more than a decade during the first quarter, and it projects that it will lose two million more during the second quarter. Most analysts had expected the streaming company to add nearly 20 million net subscribers this year. As for Meta, its shares crashed by 26% on Feb. 3 following disappointing fourth-quarter earnings and the news that it had lost daily users for the first time ever. Meta is facing fierce competition from TikTok, and privacy changes implemented by Apple have hurt its ability to lure advertisers' dollars.

Netflix and Meta are big, established companies. But in a high-inflation, rising-rate environment, they have no room for error. These larger economic forces are slowing the economy and punishing stocks of companies that don't deliver near-term earnings growth. In some cases, like Meta's, a growth stock may be beat up so badly that it becomes a buy. It's a good bet that more high-flyers will fall, and investors who determine the point at which their price becomes attractive based on their earnings could be rewarded.

Meanwhile the market is rewarding value stocks—companies whose earnings are attractive compared with their stock price. The S&P 500 growth index is down 17% for the year, while the S&P value index is down just 2.6%.

The market's rotation to value is a reminder that long-term investors' portfolios must be built to endure different market and economic conditions. A collection of high-flyers like Facebook, Netflix and others might have done well during a period of low interest rates, low inflation, and work-from-home orders—but successful portfolios must be able to hold up during market downturns like the one we're experiencing now.

With economic headwinds likely to persist for at least several more months, this is a good time to review your investment holdings. Don't hesitate to reach out to us if you'd like to talk about how you can invest to achieve your goals.

Market Turmoil Brings Buying Opportunities

Written by Rob Copeland | 19 March 2022

The start of 2022 has been very volatile, especially in the technology sector, where investors have continued pulling their money out of high-growth and richly valued shares. In less than three months, the tech-heavy NASDAQ Composite index has plunged more than 12%, bringing the index into correction territory.

Technology stocks have fallen especially far because they had flown the highest in recent years. In late 2021, price-to-earnings ratios for the NASDAQ were over 30; today they are closer to 25.

Technology growth stocks have stumbled in large part because of expectations of higher interest rates, which are seen as particularly harmful for such businesses.

Predictably, work-from-home companies have been crushed by a combination of interest-rate fears and workers returning to the office—Zoom's P/E ratio has fallen in half, from 50 to 25, for instance. But investors sold indiscriminately ahead of the anticipated interest-rate hikes. So companies with sustainable long-term business strengths have seen their prices fall as well. Apple's P/E ratio has dipped from 32 to 27. Meta—the company behind Facebook, saw its P/E ratio fall from 24 at the end of last year to less than 16 recently. Amazon, which traded at 72 times earnings late last year, recently traded under 50.

So the market's selloff has clearly created opportunities. There may very well be more volatility ahead. But right now, big, durable technology companies -- flush with cash and touting strong revenues and earnings --can be had for prices that are much more attractive than they were even a few weeks ago.

It's possible that the worst of the tech-stock selloff is behind us. The Federal Reserve this month announced its first interest-rate increase since 2018, and signaled that six more rate hikes are likely in store for this year. That's removed some of the uncertainty that has plagued tech stocks.

Still, even the best-looking stocks are long-term plays, and investing is never without risk. Geopolitical hazards are among those that bear watching. Russia has invaded its neighbor Ukraine, and the global economic sanctions against it are helping to drive up prices on commodities like gas and wheat, which in turn is driving inflation more broadly.

But geopolitics could create even stronger headwinds for markets. A scenario in which China, emboldened by Russia's aggression, ends up taking over Taiwan, could create severe shocks for the global economy. Taiwan accounts for more than 90% of the world's advanced semiconductor production.

Still, I'm long-term bullish on stocks. And now is certainly a better time to invest than six or seven weeks ago. But as we enter a rising-rate environment, the days of all stocks rising together are over. The key now is to identify companies with fundamental financial strengths and sustainable business models, and to be patient through the possibly volatile weeks and months ahead. Don't hesitate to contact us if you'd like to discuss your investments.

A Bad Time to Be Over-Diversified

Written by Rob Copeland | 19 February 2022

You've heard of diversification: Spreading your investments around to avoid being over-exposed to any one type of asset. Done properly, diversification can help reduce the volatility of your portfolio over time while keeping you on track to meet your growth goals.

Then there's what we call di-worse-ification, a situation where an investment portfolio has so many stocks that the result is unnecessary risk without the benefit of higher returns. In fact, over-diversification can be a drag on returns. Imagine you bought Apple 30 years ago, when shares were still cheap, and held it; you'd have a massive return right now. On the other hand, if you invested in an index fund whose holdings included Apple, you'd likely have a far smaller return.

That's an over-simplified example, but you get the point. The more stocks you own, the more likely your returns will mirror the larger market's returns. Owning a limited number of high-conviction stocks, on the other hand, gives you a chance to beat the market. Of course that approach is not as safe as buying the market—there's no guarantee that high conviction portfolios won't underperform.

Over the past few years, there was less downside to owning funds with hundreds of holdings: Thanks to the federal government's fiscal and monetary policies, the broad market rose, and many index funds did well. However, the Federal Reserve is now pivoting to an inflation-fighting stance. It's expected to raise interest rates and wind down the bond purchases that have been propping up the economy and the markets.

As a consequence, we're moving into an environment in which it will be more important to distinguish between promising stocks and those that seem likely to stagnate or decline in the next few years. An over-diversified portfolio is more likely to include clunkers that will increase risk and dampen returns. Yes, broad portfolios will be more likely to match the overall market's rate of return, but as the first several weeks of 2022 have demonstrated, the jacked-up returns of the past few years have likely come to an end.

If you own shares of a big mutual fund, understand that the fund may not be nimble enough to quickly get rid of worrisome holdings. Many funds loaded up on work-from-home stocks while that category boomed, for instance. Those stocks have been crashing as Covid-19 concerns begin to wane. But large funds are wary of selling big blocks of stocks because, as they add supply to the market, they drive down the price of the stock before it's all been sold.

On a related note, many funds require each of their holdings to make up at least half a percent of their total holdings. That can make it hard for them to buy promising small-cap stocks, which typically have the most runway to grow.

The bottom line: Now is a good time to take a fresh look at your investment portfolio, to ensure you're confident in the sectors and individual stocks you own, to add names where you need to, and to potentially cut loose those you're not as confident in. Over the next few years, I expect that the market will continue to be volatile, but will reward investors who have constructed focused, forward-looking portfolios. Please don't hesitate to contact us if you'd like to discuss your investments.