After a losing week for stocks, it’s time for eager investors to slow down and reconsider their strategies. Is it possible that fundamentals actually matter again, and the Federal Reserve have your back when the house of cards comes crashing down?
The problem is, retail traders and institutional investors’ algorithms have been programmed to buy each and every dip. Triple- and even quadruple-digit P/E ratios are considered normal and acceptable as the “momo” (momentum) trade rules the market landscape in the 2020’s.
Yet, relying on momo is a definite no-no. There’s an old saying in the markets: it works until it doesn’t. At some point, the momentum trade will stop working and asset prices will depend more on businesses’ intrinsic value than on momentary sentiment.
Could we be witnessing the start of this – the pendulum swinging back to sensible, value-focused investing? Just maybe, the omicron variant is just the pin that’s popping the bubble which has been expanding for years.
The angle of the rally since March of 2020 has been astounding, and technology stocks have posted gains which are increasingly difficult to justify.
Sure, it made sense that Zoom stock zoomed and Teladoc stock teleported higher last year, but the stay-at-home trade is old news and now these companies have to deliver tangible results.
In a sure sign of the “great unwind,” the highest flyers of the past year and a half performed poorly last week. Among the hardest hit stocks were Roku, Doordash, Shopify, Zoom, Teladoc, Adobe, AMD, and Etsy.
DOCU stock. Courtesy: Yahoo Finance
And if you really want to see what carnage looks like, get a load of the DocuSign stock chart shown above. Apparently, the pandemic-driven tailwinds couldn’t save DOCU stock as it plunged 42% on Friday.
Crowdstrike, Salesforce, Twilio, you name it – like Icarus flying too close to the sun, these monster winners are now falling from grace. It was an awful week for the NASDAQ, and a continuation of the downward trend that started on a particularly gloomy Black Friday.
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It almost makes me feel sorry for folks who invested in Cathie Wood’s Ark Innovation ETF (ARKK), which is basically the poster child of the “momo” trade in the 2020’s. Since it peaked earlier this year at $159.70, the ARKK fund has shed 41% of its value.
Adding insult to injury, these high-flying stocks typically pay either no dividends at all, or very meager dividends. Evidently, these companies would prefer to keep that money for themselves and spend it on marketing, R&D, or most likely, buying back shares of their own stock.
Does this mean that there’s a “great rotation” to value, a flight to safety and quality happening on Wall Street? Are overeager traders finally leaving the Ark, so to speak?
There’s a pretty good chance that the Federal Reserve will start to taper the pace of its bond purchases, so switching to risk-off mode makes sense now. Zoom, Adobe, and AMD might be good companies, but this doesn’t mean you’re supposed to buy their stocks at just any price.
The best advice I can give you is to get in the habit of reading SEC documents on these companies before you buy their shares. With some practice, you can learn to cherry-pick the facts from the hype and hoopla contained in 8-K, 10-K, and 10-Q forms.
Among the most common problems I’ve seen in these financial reports is that companies like DocuSign, Teladoc, and Doordash have revenues, but no profits. In other words, they’re spending more money than they’re taking in from sales.
Worse yet, some high-flying stocks represent zombie companies, which are unprofitable companies that can’t pay their debts, and are only in existence because people and institutions are investing money in them.
Regardless of whether this is the start of a massive rotation into value stocks, it’s never a bad idea to check companies’ fundamentals and make sure that what you’re buying is actually worth the price tag.
Otherwise, you could be the last one standing – which isn’t good if you’re playing a high-stakes game of musical chairs.
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