April is the cruelest month, breeding
Lilacs out of the dead land, mixing
Memory and desire, stirring
Dull roots with spring rain.
There is no end to the interpretations of what Elliot meant in the opening lines of The Waste Land. Many assume he was writing about the effects of the first world war, yet he wrote it while he and his wife were recovering from The Spanish Flu.
For the markets, April really was cruel. Year to date, the S&P is down 13%* and the AGG iShares Core US Aggregate Bond ETF, a measure of the bond market, is down more than 9%*.
As interest rates rise, and they are rising, technology companies and those with high multiples to earnings are struggling. Wait, what? What does that mean? When you hear of stocks “trading at high multiples” it refers to the relationship between the price of the stock and the earnings or profit each share of stock represents. (For reference, JPMorgan currently trades at about 10 times what each share of the company earns. In contrast, Tesla currently trades at about 71 times earnings. So, you could say Tesla is 7 times as expensive as JP Morgan. But which is the better value? Here is where it gets tricky. Tesla is growing faster than JP Morgan, so many think it deserves the higher multiple. It does deserve a higher multiple, but how much higher? We don’t really know what the future will bring or how much Tesla will grow in the future.)
The group of stocks that we call FANG (Facebook, Amazon, Netflix, and Google) are all down more than 20% this year with Netflix down an astonishing 69%, considerably more than the market average.*
Why are technology and other highflyers down so much? Perhaps because we had so much hope for them for so long but mostly, I think it has to do with slowing growth and a return to more normal interest rates. Yep, as painful as it may seem, a return to more reasonable interest rates is probably a good thing – but it hurts companies with high multiples to earnings. Why? Because pricing models that attempt to evaluate risk and expected return out into the future (CAPM) use a risk-free rate of return. Investors expect to be compensated for the risk they take and the time value of money. As interest rates rise, they expect more return for the risk they are taking over the risk-free rate of return, usually the 10-year treasury which just touched 3%.
This may be why technology companies that typically trade at higher multiples are being so hard hit. If growth is slowing or uncertain, and interest rates are increasing or uncertain, you aren’t quite sure what you should pay for future earnings. The markets hate uncertainty and I think that is what we are seeing so far this year.
OK, so what, you say? If our economy is to rebuild itself after the effects of the past two years, and dare I say since the last financial crisis, interest rates are going to have to go back to normal. Zero is not normal. 0.50% on the 10-year treasury is not normal. A healthy economy will have to reward investors for being patient again, for being willing to lend money to companies and pay for growth at a reasonable price. This realignment will take some time. Interest rates will stabilize, growth will return, inflation will get under control, and investors will be willing to pay for companies that develop new technologies and new ways of doing things.
So, maybe this is our Spring. Difficult at times. Cold and cruel at times, but with the hope and promise of warmer days. How do we play it? Do we wait for the warmer days of summer? Does the lilac wait for June?
Here is what I suggest:
- Focus on what you can control. You can’t control what the market will do but you can control how much you spend and save
- Review your goals, the risk you are willing to take, and the rate of return you expect for taking that risk
- Know what you have. Take stock of what makes up your savings and investments and reevaluate regularly. We suggest quarterly.
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