Internalizing Stock Market red (in 5 images)
In light of the recent market downturn (still underway), I’ve been flooded with some pretty panic-stricken messages asking for my opinion and felt compelled to address the topic a bit.
I hope the following 5 captures are useful:
- It seems that market participants as a whole may be experiencing feelings ranging between Panic and Anger
2. And those investing in small-cap companies might even be more uncertain. The $IWM (Russell 2000 small-cap index ETF) recently violated the $211 support level after a long consolidation phase, with the next possible support levels perhaps at $191, $187, or even further below
3. But despite the downward movement, this moment in time isn’t about small-caps. This is affecting the larger pool of US stocks, especially growth companies. The following graph shows the ratio of puts-to-calls, or in other-words the behavior of market participants wanting to be invested in stocks. And we’re getting close to the “The Market is Never Going Up” mindset last present during the COVID crash.
4. While these stances are more technical in nature — stock charts by definition measure investor behavior — let’s consider a fundamental view as well. Below is one valuation of the S&P 500 using a standard DCF (Discounted Cash Flow) model, from January 1, 2022, which suggests an intrinsic value of $4,320. The price at the time was $4,766, or 10% higher. Well, as of today, it’s $4,397, which is 1.8% higher. The model of course depends on certain assumptions, so feel free to build your own with your own assumptions and sensitivity.
5. Yes, the stock market has the reputation of being the world’s largest casino, but this “casino” happens to be played by lots of professionals that manage very large sums of money, many of whom care deeply about quarterly earnings. So welcome to Week 2 of earnings season, which can also affect how some of this market action continues. Last week, large-cap companies like Netflix reported results and guidance that fell below expectations, failing to give the market the type of catalyst it could have used to better resist the overall downward trend. But this week we have lots more major companies reporting: Apple, Microsoft, Tesla, Visa, J&J, Mastercard, Chevron, GE, and so on.
So… my opinion? Well, it’s simple, boring, and unoriginal: Practice good risk management, such as diversification and gradual entries in and out of positions, especially as this volatile period continues. While there is so much we can’t control, such as interest rates, inflation fears, and sentiment, there is plenty we can control, such as thorough research, financial modelling, and position sizing.
Best wishes to everyone, and above all else, please stay healthy.
