Buy Intelligently When Others are Fearful
Investing legend Warren Buffett coined the phrase, “Buy when others are fearful and sell when others are greedy.” We have added the word “intelligently” to this phrase to demonstrate one has to have an awareness of what is happening in the market and execute on your strategy accordingly.
We touched bear territory on Friday on the S&P 500 intra-day low with the index hitting 3,811 which was 20.6% off the closing highs of January 3rd of 4,797. Remember, a bear market is defined as a drawdown of 20% or more. We subsequently rose 2.36% off the intraday low to close at 3,901 – just over even for the day and 18.7% off of the January 3rd high.
This latest round of selling was triggered by the poor earnings reported by Walmart and Target this week. Target reported record revenues, but the margins got squeezed as a consequence of building up their inventories. The inventory build was in response to the supply chain disruptions and, in an effort to insulate themselves from this, they overshot and bought too much inventory which ate into margins which dropped their earnings per share.
Paradoxically, the excess inventory may actually be deflationary as retailers look to discount to clear out their inventory. If this happens, we may see the CPI (Consumer Price Index) start to subside which will give the Fed cover to ease off on interest rate hikes.
So, what we think is happening is course correction in the economy – the pandemic led to supply chain disruptions, the government response to the pandemic led to excess demand in the form of cash payments to middle-class and lower-class citizens. This segment of society tends to spend most of what they receive, thereby creating excess demand on a system already strained due to supply chain disruptions leading to inflation. Supply chains started to loosen up and retailers took advantage of this in fourth quarter by building up inventory. That inventory did not get worked off in first quarter therefore margins were affected. Demand was not as strong as the middle and lower classes did not have as much cash on hand and have started returning to work which has been manifested in an increasing labor participation rate.
So, we think second quarter will be tell-tale as to whether retailers can work off inventory. If that work-off of inventory is deflationary, then the Fed can ease off and we can settle into a new normal.
The practical application of all this is we think our strategy is sound – we have been holding off on rebalancing portfolios since we noticed the death cross on May 2nd. The death cross is a technical indicator which happens when the 50-day exponential moving average crosses over the 200-day exponential average signaling further decline ahead. We have been waiting to see two sequential days on increasing volume which would be an indication of a reversal of trend.
What is fascinating about all of this is that fundamentally, the market has returned to its long-term averages on the price-to-earnings ratio. This is the price of the stocks over their earnings per share. We are now at 17 times with long-term averages being 16.88. In other words, stocks are fairly valued. Not only that, but value stocks are below their long-term averages and represent a substantial buying opportunity.
Friday’s continued sell off at midday suggest we had not hit the bottom yet, but the strong buying at the end of the day was a positive sign. Today's market activity was another encouraging sign with the S&P ending the day up almost 1.9%. Rest assured, when we see a confirmation of reversal of trend, we stand ready to execute to capitalize on this. Once we get this confirmation, we will move to rebalance all portfolios and add value exposure to both our mid-cap and small-cap holdings. In essence, buying intelligently when are others are fearful.
As always, we appreciate the trust and confidence you have placed in us to faithfully steward your financial resources.
Please don’t hesitate to reach out if you have any questions or concerns.
Troy and The Boulevard Team