Here we go again. From late March 2020 till almost the end of last year, stock markets had been on an extraordinary tear. When the pandemic exploded, market plunged close to 30% in a matter of weeks. Aggressive government action by the Fed and then Congress staunched the panic, and from then until November 2021, the S&P 500 doubled, with the Nasdaq up even more. Since then, and accelerating sharply the past two weeks, markets have sold off, with Nasdaq declining almost 15% late last week, the S&P 500 flirting with a “correction” down 10% and many of the high-flying names of the pandemic— from Zillow to Zoom, Netflix to Peloton, off 60% or more. What the markets giveth, they taketh away.
What everyone wants to know in these moments is simple: is a further market collapse ahead or are we done? Markets then rebounded sharply in the past days, but wild swings are often a sign of more wild swings to come. Is this just another volatile period or the start of a more ominous breakdown? The answer is always the same: no one knows. But there are a few things we do know: there is no sign of an overall economic collapse or even sharp contraction. GDP for the United States grew 6.9% in the most recent report. Yes, that torrid pace is now slowing, but even with inflation running hot at 7% year-over-year at least read, wages are rising, unemployment is astonishingly low, and there is no sign of the market breaking down, as it did when trading had to be halted multiple times in March of 2020 because the sheer volume of selling triggered circuit-breakers. The rotation out of high-flying tech and pandemic-themed stocks has been unusually brutal, but from a technical perspective, it has happened in a rather orderly fashion. That is a signal of underlying stability.
When markets crashed in March of 2020 or in the fall of 2008, there were legitimate reasons to ask if something fundamental had shifted and if we might be on the brink of the type of a major collapse—last seen on the Nasdaq in March of 2000 and with the Dow in October 1929. Today, such concerns are more a stretch.
Whenever these sharp corrections and pull-backs occur, the bears come and out and play. Jeremy Grantham, founder of a large asset management company called GMO, has been chronically negative about stocks for many years, but he took the opportunity of the weak start of the year to announce that this is the start of a massive “super-bubble” popping. Last year, he warned of an “epic bubble,” but since then it has inflated further and now has even more to fall, as much as 50%.
Others have echoed the sentiment, announcing that not only have pandemic stocks collapsed but the prospects of inflation, higher interest rates, end of years of “easy money” supplied by the Federal Reserve, supply chain issues, war drums in the Ukraine and a possibly chaotic midterm election in the United States are a toxic cocktail for stocks and that most investors would do well to get out or at the very least hunker down in safer names that didn’t fly high and are less likely to crash and burn.
In many ways, there is a predictable cadence to how people react when stocks sell-off just as there is when they soar. “I told you so” becomes a common refrain, a tsk-tsk that any sane person should have known that this was coming, that the writing was on the wall, that what goes up must come down. And of course, there is, some truth there. A significant portion of the markets the past two years have been fueled by global central banks that opened money spigots to cushion from the blow of shutdowns and border closures along with very low interest rates for years. Professional investors started speaking of a “Fed put,” which refers to the idea that the Federal Reserve was committed to bolstering asset prices (stocks and real estate, mainly), as a way of keep the economy humming. Now, as the Fed prepares to raise short-term rate targets, many investors have concluded that the Fed put is dead.
Clearly, this has been an intensely bearish few weeks for hundreds of stocks that flew high after March of 2020. 40% of the 3000 Nasdaq stocks have lost 50% or more in the past few months. But the overall indices have been much less volatile. Yes, there was also a sharp correction at the end of 2018, but it is unusual for so many names to lose so much while the overall markets have been down but relatively stable. Higher interest rates looming is a major factors as investors assume that when capital is more expensive, companies that are barely profitable and burning lots of borrowed money will have a harder time establishing viable long-term profitability.
That assumption, however, may be flawed. The cost of capital is about to go up, but from a historically low base. Even if interest rates go up by 1% over the year, which is about what’s expected, we will still be in a comparatively low-rate environment and there is as yet no indication of the tightening in the credit markets that has often spooked investors even more. Even more crucial is that the assumption that rising rates will crimp these more speculative businesses or severely dent the profitability of retailers or industrial companies (all of which have seen steep declines) is just that: an assumption. There is another equally compelling patter, which is that in the absence of a recession, U.S. stocks have been up 9 of every 10 ten years.
This year has already been the worst start to a year since…forever (actually 2009, but who remembers that?). Then again, it’s also only been a month. But a down year is not the end of times, or the sign of a massive bubble, and in truth, if bubbles are what one is looking for, in those few thousand names that have cratered in the past few months, the bubble has already burst. Could that metastasize into real estate and more blue-chip companies like Microsoft and Proctor & Gamble? Sure. But possible isn’t the same as probable.
We are in another period of flushing out some of the speculative money that went into meme stocks like Gamestop a year ago and into a wide range of newly minted public companies such as Robinhood. There is also an extraordinary amount of computer-generated trading these days. Not many actual humans are sending the same stocks up 10% one day, down 8% the next and up 9% the next, yet that has been rather common of late. Even with the steep sell-off, however, most companies that have collapsed have still seen heady returns over a two-year period. It’s no fun at all to watch paper returns evaporate, but unless you are actively trading and chasing, much of the pain is as ephemeral as much of the gain was.
Nothing in the real world suggests an imminent problem of major proportions. War in Ukraine could certainly be another shock; a new COVID-19 variant could be as well. But unless and until credit markets start to breakdown or employment sharply erodes or inflation truly gets out of control, these market moves are as incidental as some of the moves up were last year. And none of the reasons for this self-off preclude a climb back given such robust real-world dynamics. Above all, in times such as these, beware those who speak with oracular certainty. The world is far too fluid to be so simply predictable.
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