What goes up, must sometimes come down
What the Market? - Jan 24, 2022
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What the Market?
Mr. Market is in a bit of a mood isn’t he? After a long period of illogical and astronomical valuations Mr. Market decided it’s time to make things right. Markets have posted back-to-back-to-back-to-back weekly losses pushing the Nasdaq index into correction territory and bonds hitting two-year highs. Since day one of 2022, volatility has increased 67% (50% last week alone!). The biggest driver? The Fed’s radical change in attitude towards hawkish policy.
What’s driving the market?
You had TWO jobs!: The Fed has a dual mandate in the United States; to promote maximum sustainable employment and ensure stable prices (a.k.a. manage inflation). Analysts believe the Fed has grown comfortable with employment levels and is changing its focus towards controlling inflation. To do so, the Fed will likely pull on two of its key levers: reserve rates, and interest rates (tighter monetary policy), after tapering its quantitative easing program last November. The Fed should start by raising interest rates. Reserve rates are likely to increase next if interest rates are not enough to curb inflation.
By increasing both, the Fed can discourage borrowing and encourage savings, ultimately slowing down the velocity of money. In an economy where consumer confidence is high (which it is in the US) this reduces the currency supply and sends the message that the currency is valuable and worth saving (apply supply vs. demand concepts and we get a stronger currency and reduced inflation). This process is referred to as “cooling off” an overheated economy.
The Fed Meets: On Tuesday, the FOMC will meet to discuss upcoming monetary policy plans. Although no immediate changes are expected, it will likely set the tone and groundwork for an initial interest rate hike in the coming months. It’s expected that the Fed will continue providing hawkish signals but what’s hoped for is a clearer indication of when the policy belt will tighten.
What’s an investor to do?
The significant changes in monetary policy to tackle inflation have naturally introduced a new element of uncertainty in the market. Markets hate uncertainty, and right now we don’t know the exact application or impact of the Fed’s decisions which is prompting the spike in volatility and a correction of speculative / growth stocks. Recall, speculative / growth stocks are likely to be borrowing large sums of cash to fuel their growth and are more sensitive to changes in interest rates.
The current market correction should not be a shock - we’ve had a long and irrational pandemic bull market. Valuations remain significantly above historical values even when accounting for the enormous amount of global stimulus support. A pullback is healthy every now and then, particularly after the bull run we’ve had. Economically, nothing looks particularly wrong - some folks may be cashing out and waiting for the new playing field to be set by the Fed.
If watching your portfolio dip 50% is losing you sleep, consider moving to cash or transitioning to value stocks that are less reliant on borrowed capital. For the love of a New York slice, get out of the trend product companies who’s valuations cannot possibly be justified by their offerings (looking at you LMND at $183, PTON at $167 and ZM at $478 - who are we kidding?)
Keep an eye on the economy
Aside from the Fed meeting, some of the biggest companies in the world will be reporting earnings this week. Take a look at what they have to say about the current macroeconomic context and the challenges ahead in 2022.
The Curious Investor
An update on Visa (disclosure: WTM is long V)
Visa has made a significant recovery from the 2020 pandemic-driven slump and continues making strides to grow as the world re-opens. This week, Visa will report Q4 earnings - let’s take a look under the hood.
Macro environment: The name of the game is gross-payment-volume (GPV). Key factors to consider are global macroeconomic stabilization, broadening merchant acceptance, reactivation of global consumption, easing of travel restriction, and accelerated adoption of electronic payments. All of which should play in Visa’s favor over the coming years.
Unique growth drivers:
Travel-related, cross-border, credit card volumes: represent one of the largest and most profitable verticals for Visa. Currently, volumes remain below pre-COVID levels. It’s just a matter of when it will recover.
FinTech’s boosting payment volumes, globally: Visa remains the dominant network globally, and particularly in the US. Leveraging the company’s strong brand name, global coverage, and receptiveness to developing technologies has made Visa a go-to for FinTechs enabling new payment methods and processes. As FinTechs grow, they will increase the volume and velocity of money that travels via Visa’s network.
Constantly developing its edges: What has always set Visa apart from the pack is their ability to consistently innovate and move with the market. Visa was the first major incumbent to dip into the crypto space and help new FinTechs navigate regulatory requirements and find product-market fit. Furthermore, Visa directly invests in numerous FinTech startups; keeping its ear close to the ground of developing technologies. Despite the 2020 slump, Visa has a sustained R&D and inorganic growth strategy to sustain its competitive edge. Visa tends to focus in on P2P, B2B and faster payments models and partnerships.
CEO Alfred Kelly: The captain at Visa’s helm since 2016, Kelly has been a major catalyst in Visa’s embrace of market innovation. Kelly has been quick to jump on disruptive trends on the edge of Visa’s scope make it a part of Visa’s core. He brings the threat inside and uses it to make Visa a stronger company. Recent examples include the acquisitions in open banking platform, Tink, and FinTech foreign exchange solutions provider, Currencycloud. As long as this is Visa’s mentality, we’re here for it.
Let’s talk prices: Regarding the valuation, Visa has been trading at relatively attractive prices. Historical, comparable and forward earnings ratios look like a fairly decent opportunity to buy (under $200 looks appealing to us).
Wait…I thought you said valuations are irrationally high? Yes…but not all are irrational. Visa’s business model is well established and stable and growth is currently dependent on the macro-environment. This isn’t a meme stock or cult trend investment vehicle.
Its re-assignment in the S&P from the IT sector to financials added to recent volatility without much rationale. Earnings have been strong and consistently above market expectations. It’s been quite a weird run for Visa as of late. Let’s see what happens.
Key metrics to look out for: Cards growth, Gross-Payment-Volume (GPV) and total processed transactions (cross-border vs. domestic)
Consumer Products: Colgate-Palmolive, Modelez, Altria, Sherwin-Williams, McCormick, Kimberly-Clark, Whirlpool, McDonalds
Consumer Cyclical: JetBlue, Alaska Air, Polaris, Southwest Airlines, Las Vegas Sands
Financial Services: Visa, RobinHood, Mastercard, T. Rowe Price, Stifel, American Express, Invesco, Blackstone, Capital One
Communications: Comcast, Verizon, AT&T, Charter Communications, Juniper
Pharma and medical: Abbott, Johnson & Johnson, Danaher
Others: Caterpillar, General Electric, Tesla, Chevron, Haliburton, US Steel, 3M
Defense & Aerospace: Lockheed Martin, Raytheon, Boeing
What we’re vibing:
Ronny Chieng: We don’t know how, but we’ve just discovered comedian Ronny Chieng. This man, is absolutely hysterical. Just watch some clips and then you’ll be diving into his specials.
After Life by Ricky Gervais on Netflix: This British comedy-drama series by Ricky Gervais is the best we’ve seen in a while. It is equal parts hilarious as it is thought-provoking. The show impeccably walks a thin line between comedic gold and the force of life, touching upon death, suicide, dementia and loss. Try not to binge watch it, if you can.
A content guide to investing (books, books, books!)
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