The stock market might be down 4% but it’s been a wild ride in the first weeks of 2022, having been down over 10% only two weeks ago. What’s going on? The market is in transition as interest rates climb. We have been arguing that panic is not necessary because of the glut of savings weighing on interest rates. What it does mean is that you need to be aggressively managing your portfolio. Stock picking has never been more important.

Value is All Important

Before we get to stocks, I want to spend some time on the big forces at work. You will have seen the big selling in some stocks, most notably Facebook, now known as Meta. Much of this selling has resulting a hoovering up of Amazon stock.

The point is that the momentum trade is no longer working. Big funds like Magellan backed Meta and Google (Alphabet) on the premise that their business models utilised the network effect (consumers using their sites leading to a dependency from retailers) creating exponential sales growth ad infinitum. Some of these players are clearly being disrupted, which has debunked this theory, certainly to the extent of limitless blue sky.

If you doubt the transition towards value, look at our own market where 2021 laggard AGL Energy (AGL), having fallen 50% in that period, and which Blue Chip Value rated Buy this month (14 Jan 2022 / Issue 95) has bounced 11% having been up as much as 22%.

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The Lesson: Don’t Buy into Blue Sky Based Valuations

This has happened since time immemorial, remember IBM and the nifty fifty in the 1970s? There is no such thing as a bullet proof business model.

Some of the stocks in the recent sell-off have declined 50-80%, but significantly the major indexes have declined less than 10%. The index is the key. When stocks get into the index it supercharges their share prices because funds are forced to buy them. When they leave, it has the reverse effect.

Is index capitulation a risk? Yes and no. The point is that individual stocks have been hit hard but money has moved into others. Opportunities have been created. If there is a wobble in the index, it provides good hunting for diamonds amid the rubble.

The Ukraine

War on the edges of Europe is always bad. This is a risk, but is a long tale risk. You would not sell out of the market based on the low-single-digit probability. This is not to say you don’t keep an eye on it, but the evidene from both Gulf wars is that huge profits are made buying on the day of attack (although this threat is in Europe).

Open for Business

The big positive we can see for the domestic market and indeed global markets is the world opening up. Almost two years after Australia shut its borders due to the pandemic, the country is finally reopening this month for international travel.

This has massive ramifications not only for tourism and education, but also for consumer spend. Prior to the pandemic, spend on services was growing at the fastest rate. This spend will slowly but surely accelerate once again, at the expense of goods, which have been the big beneficiaries in 2020/21.

The Big Risk

Once again I have to come back to interest rates. Despite the weight of capital keeping them at historically low levels, it seems that the world’s central bankers have been slow to tighten the loose monetary policy during the current inflationary period.

Not only have we had near zero interest rates, but they’ve been continuing to buy bonds and print money in various Quantitative Easing programs around the world. Inflation in the US is at 7% on an annualised basis, and the implied level of inflation (the difference between 10 year US Treasuries and the Yield Inflation Protected Treasuries or TIPS) is approaching 3%. This is well above the US Federal Reserve’s 2% target.

The big experience from the 1970s is that if you leave monetary policy too loose for too long, you have to tighten too aggressively, which acts like a hammer on growth.

The Big Takeout

There are big shifts occurring, but there are also opportunities in stocks that have been unnecessarily punished. Stock picking is the key and this involves picking stocks that have good fundamentals – strong balance sheets, visible earnings and of course, growth!

You need to have a diversified portfolio where you have exposure to stocks that have big potential for growth (see our Small Caps publication) and also those that are producing consistent growth and dividends.

We concentrate on taking profits on the way up and then picking up bargains when they become available. We’re in it for the long-term, after all (with some quick profits along the way too).

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