Just a couple of months ago, Fear, Uncertainty and Doubt (FUD) enveloped the markets. From its high in Nov 2021 to Dec 2022, the Nasdaq went down by nearly 35%, and the S&P 500 index went down nearly 25% in a similar timeframe.
The Nasdaq has recovered 17% this year since its near-term bottom. Some analysts are now calling it a bull run, as the Nasdaq has risen 20%.
Although the recent US bank crisis has affected many stocks in the S&P 500 index, it has still recorded a “bull run” with a 20% gain from Oct 2022 to Feb 2023, although it rose much less than the Nasdaq this year.
During this uncertain period, there was no clear consensus to buy. Some advised buying the dip, while others suggested selling while you can, as they believed the worst was yet to come.
The table below shows the perspectives of the buy/hold group versus the sell group. The reasons on the left column of the table broadly explain why I did not sell US stocks when everyone said to sell.
| Reasons why people thought they should buy/hold | Reasons why people thought they should sell |
| Market has dropped a lot (its cheap) | Market hasn’t dropped enough (its not cheap enough) |
| Earnings has bottomed | Earnings will drop further |
| Interest rate hike is almost done | Interest rate hike is not yet done |
| Mild recession | Severe recession |
| Short term business outlook deteriorated less than stock price | Short term business outlook deteriorated more than stock price |
| Long term fundamentals remain intact | Long term fundamentals changed |
There also a few more considerations that we will discuss in detail:
Valuation of the perceived safe haven known as the S&P 500 index
Let’s take a look at these charts that show the current valuation of the S&P 500 index from three different perspectives – price to book (P/B), price to earnings (P/E), and earnings yield. (Charts are based on Sep 2022 quarter’s financials.)
Looking at the P/B ratio, we can see that although the current levels have come down quite abit from the peaks, they are still much higher than previous peaks. This is similar for the P/E ratio and the earning yield metric.
This could be perceived as value to some investors who believe in the strong growth and earnings profile of many companies that are part of the S&P 500 index.
A significant proportion of the S&P 500 Index are made up of the biggest companies in the world and could be viewed as a safe haven in challenging times.
TINA vs TARA
TINA vs Tara stands for There Is No Alternative vs There Are Reasonable Alternatives.
As at 31 March 2023, the fed risk free rate was 4.75% and longer tenor bond yields ranges from 3.56% to 4.11%. Some investors felt that such yields would be adequate returns and switched from equity to bonds or other cash products. Hence, there seemed to be a reasonable alternative to these investors.
However, these yields are much lower than current inflation levels and while there is the adage that Cash is King, it seems like cash is not king in the face of inflation. To these investors, there is still no alternative!
Inflation tends to bring down profit margins for companies in the short term, especially those without pricing power or the ability to quickly adapt.
However, equities are perceived to be a good hedge against inflation in the medium to long term as price inflation would gradually cycle through the supply chain as companies adapt and gradually increase prices.
The chart above shows that cash is flooding into money funds even as equities continue to climb up.
This could be due to investors trying to deploy all their cash, seeking higher returns for their portfolio by making their money work harder, whether by deploying into money funds or equities. Note that it is less probably that investors are leveraging up due to the high cost of funds currently.
Closing statements
Michael Burry of the Big Short admitted that his bearish warning about the stock market earlier this year has so far been proven wrong by traders lining up to buy the dip. He also said that there is no other generation in the last century that has bought the dip in the way investors have been doing so in 2023.
This could be due to bargain hunting but whatever the reason, looking at the chart above which shows that year 2023 has been a year where dip buying pays off.
The S&P 500’s average return the day after a down day has been much higher than the past.
Warren Buffet has been quoted saying “Well, the best thing to do is buy a stock that you don’t ever want to sell”. He has the reputation of being one of the longest investors of many well known stocks such as Coca Cola and Apple and has recorded remarkable returns. Sounds to us like this could be something to follow.
