Since the day after Thanksgiving, we've seen significant selling take place in global markets as prices flushed out fast. In this post we want to highlight two catalysts for that volatility, then provide perspective on what it means going forward.
There’s been a significant drop in MAPsignals’ trusty Big Money Index (BMI), which measures institutional investor buying and selling. But please note that it’s nowhere near oversold, even after the recent volatility:
Let’s dive a bit deeper and review different sectors’ performance over the last week:
One quick, obvious takeaway is that most everything was red across the board. Significant pain came upon technology, discretionary, communications, and materials. Small-cap stocks were hit hard too. But let’s also look at the annual return column – green everywhere. Annual returns are spectacular across the board, even with the volatility.
Additionally, the following two charts show the heavy selling (red bars) in both stocks and exchange traded funds (ETFs), which are moving in conjunction with the overall sector flush out:
Still, it’s important to consider the macroeconomic data alongside these charts to understand where the pain is coming from. The most important thing we've noticed when looking under the hood is that selling was most focused in stocks with weak fundamentals.
When looking at MAPsignals data, out of the 442 sell signals from last week, the average fundamental score was a mere 47% (out of 100). Just 12% of those sells had fundamental scores greater than 65% (out of 100). The stocks with fundamental scores less than 65% that were sold had an average profit margin of -759%. All told, that means 88% of stocks sold in the last week had mediocre or poor sales and earnings growth on both a one- and three-year basis.
So, the recent sells were investors removing unprofitable and/or poorly run companies from their portfolios. Therefore, value hunters should be looking for sectors with strong fundamentals (i.e., quality stocks).
From a technical basis, this heavy selling is an extreme reading. Typically, a situation like this creates a strong base for the market to bounce back. But even with that said, we would be remiss not to discuss the two big news stories that caused the volatile washing out of stocks with poor fundamentals.
The Omicron Variant
News of the new Omicron variant of COVID-19 greeted the world the day after Thanksgiving. While this discovery rattled markets somewhat, the real cause of the market reeling was the announcement of new travel restrictions, which inhibit economic activity.
At CFS, we are not virologists. In fact, we have no medical expertise at all. And our opinion on Omicron should not be seen as medical advice or any sort of prediction based on medical science. We’re looking at this situation strictly through a market-based lens.
With that in mind, we think Omicron is another of what will probably be many variants of COVID-19 over the course of time. For markets, it's not the new variant that is the problem, but fear of the potential reaction.
As we stand here today, it’s becoming clearer the “Zero COVID” strategy that’s been pursued since the pandemic began is most likely unattainable. Many countries have abandoned it. It seems the virus is here to stay in some form or fashion. That said, it’s possible COVID-19 could gradually become like the flu, where there is a vaccine booster available each year, depending on which strain is most prevalent, per Dr. Anthony Fauci, the top COVID-19 advisor to President Biden.
In our opinion, while the market reacted to potential government responses, we think the sell-off was overblown. At this point, we don't believe widespread shutdowns are a likely response to this or any other variant. More U.S. shutdowns would create a political environment that would likely induce a significant Republican wave in the 2022 midterm elections. Democratic political strategists will almost certainly be cautioning their party's leaders not to risk such a scenario.
Therefore, from an investment perspective, we believe it is best to ride the COVID-19 rollercoaster and stay focused on fundamentals. That means circling in on quality companies with strong earnings and revenue.
Welcome to Reality, Chairman Powell
The second headline that caused significant market volatility last Tuesday, Nov. 30, was Federal Reserve Chairman Jerome Powell finally admitting that it is time to retire the term “transitory” for inflation. He believes it will be with us through 2022.
As a result, he said the Fed will discuss speeding up the tapering plan for its bond buying program. The Fed is buying $120 billion of bonds every month currently. The tapering plan calls for a reduction of $15 billion per month until July 2022. However, that could all quicken if inflation keeps climbing.
So, we’d like to welcome Chairman Powell to reality. Have a seat with the rest of us who have been saying for a year or more that inflation is running rampant.
Data is Bullish and Should Eclipse Fears
Now that we've gotten the fearful headlines out of the way and discussed the importance of quality in earnings, it’s time to point out how we see optimism going forward. Here are four reasons to be bullish about the future.
As we discussed above, the majority of the selling was for low-quality, bad fundamental companies. What matters most is earnings, and as you can see in this Bloomberg chart, the 2022 and 2023 earnings estimates are still strong:
We're seeing increasing economic recovery, most recently exemplified in the ADP jobs report from last week, which showed an increase of 534,000 jobs:
The trusty BMI is nowhere close to being oversold.
In our opinion, these datapoints outweigh recent events and the fear-based reactions discussed above. Thus, for investors, patience is the name of the game. It should pay off in the long run, as it does almost every time.
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