It’s been a while since I last posted anything.

Since then, there has been a lot going on in the markets so let’s take a look at where we are now.

Dow: -13.9% from 52-week high (also ATH)
S&P 500: -18.3% from 52-week high (also ATH)
Nasdaq: -29.9% from 52-week high (also ATH)

Markets have clearly tanked since the Fed started hiking rates and trimming its balance sheet (quantitative tapering).

On the other side of the coin, the economy seems healthy. While the inflation situation is getting ugly, the jobs market is strong and unemployment remains low. There are a few headwinds such as inflation and the potential of rate hikes eventually feeding into the real economy (mortgage rates in the U.S. have risen sharply to above 5% p.a.) but as of now, that doesn’t seem to be built into the market expectations.

Cheap but not dirt cheap

With the pullback in markets, the natural question that many people have is: Is this a good time to buy?

This is by no means financial advice. My own take is that markets have not overreacted that much. The drop so far is just a natural outcome of rates increasing while also reflecting the expectation of a few more rate hikes in the months ahead.

Anyone who has done a finance 101 course will know that the value of equities is just the present value of all expected future cashflows. This means that any drop in value could be due to a combination of these THREE things – (1) an increase in the discount rate, (2) a drop in future cashflows, or (3) a drop in the expected growth rate of future cashflows.

In my opinion, what we’re seeing right now is just the market reflecting an increase in the discount rate due to rate hikes.

What’s the evidence?

According to the latest Revenue, Earnings & Margins briefing by Yardeni Research, the revenues, earnings, and profit margins of the S&P500 are expected to continue growing (in the case of revenue and earnings) or at least remain stable (in the case of margins).

Furthermore, the drop in the Nasdaq versus the Dow and S&P proves that the rerating is happening to growth stocks that had most of their value derived from cashflows far out in the future. Even within tech, the 30% fall in the Nasdaq papers over the fact that the most speculative (chart 1 in link) and meme-y of stocks have fallen anywhere from 70-90%.

Another piece of evidence that I would like to submit is this:

Source: Novel Investor

Notice anything about 2008?

Of course, the difference is that in 2008, the financial sector had a meltdown that threatened to spill over into every other part of the economy. But that’s the lesson – when the real economy gets hit bad, there’s nowhere to hide.

Right now, there’s a bright spot within the S&P which is Energy. And even within certain sectors like Consumer Staples, brewers and tobacco are doing well. The downer is that Industrials, Consumer Discretionary, and Transportation and also down which could be a harbinger of things to come. You can check out the lovely charts here.

Last but not least, look to the Straits Times Index. Our good ol’ STI hasn’t gone anywhere (up nor down) in a major way which suggests that the global economy is not at serious risk of tanking. If anything, the STI is full of old-economy stocks that depend largely on the outlook of the world economy.

What’s an investor to do in these times?

Well, if you don’t have bullets left, then what else can you do but ride out the waves?

If you do, now might be a good time to slowly start Dollar-Cost Averaging (DCA) in the markets. You shouldn’t be surprised if markets drop further and you also shouldn’t be surprised if it takes a while to find a bottom.

If you’re wondering what to DCA into? I would start with a broad-based index fund. If you really have to scratch the stock-picking itch, then pick only high-quality stocks that only rely on modest amounts of debt to produce reliable free cashflows to equity.

A word on crypto

It’s pretty clear by now from all the crypto experiments that cryptos are just another currency. Currencies depend a great deal on the faith of the holders of the currency and when that faith disappears, you can expect that same currency to do so.

The story currently unfolding is about the Luna and Terra coins. Despite all the hype surrounding the concept of Terra being an algorithmic stablecoin, it has quite quickly become destabilized. I’m shocked at how many people online are saying that they put their life savings or substantial amounts into this thing.

Hopefully that most people only lost what they could afford and the “wealth” that disappeared is merely the illusionary paper gains that they saw in their wallets as the price of Luna climbed. Anyway, it’s times like these when economics act like gravity and pull these things down.

In short, don’t be a Lunatic.