Dear readers,
It seems the stock market is still on holiday, with few major announcements to comment on. I’m assuming you have no interest in what 10-year treasuries did this week (by the way, they rose) or how Bitcoin is teetering on the brink. If you do, let me know, and I can include these topics going forward. I expect noteworthy activity to pick up in the next week!
Kind regards,
JL
Growth Pains
This week, the tech-focused Nasdaq posted its worst annual debut in six years, with a drop of 4.5%. The slide reflected a wider rotation from growth into value stocks, which is illustrated by the stability of the Russell 1000 Value index (RLV) versus a decline in its Russell 1000 Growth counterpart. Note that these indexes categorise stocks as either value or growth based on their price-to-book ratios and forecasts (not exactly a holistic assessment of value).
The rotation into value has been attributed to expectations that the Fed will raise rates at a faster pace than initially planned; a falling unemployment rate indicates that the economy is healthier and can be weaned off economic stimulus sooner rather than later. In theory, growth stocks will suffer disproportionately in this scenario, as debt financing turns expensive and cash flows far in the future become less valuable. In contrast, value firms, which typically have a lesser need for debt financing and pay lower rates anyway (many are established firms that already produce cash and are thus more creditworthy), will win investors’ attention.
The ‘value is dead’ perspective has only gathered momentum in the bull run of late, and it’s easy to see why; the RLG growth index has produced a return of roughly 475% since 2012, compared to 225% for RLV. However, cyclicality runs deep in economics and finance, so there’s lots of speculation that the tide is turning in favour of value - it’s still too early to say, but I’m certainly rooting for it.
In any case, it seems there’s plenty of pain to come for the frothiest areas of the market, with technology being the prime target. Cathie Wood - whose funds are overly exposed to this sector - is in a precarious position, with the flagship ARKK ETF already down 10% in 2022.
The Ultimate Milestone
The world’s most valuable company, Apple, flirted with a $3 trillion market capitalisation this week. Frankly, I don’t know what Steve Jobs would think, especially as the firm hit $2 trillion in value as recently as Q320.
For context, the nominal GDP of France in 2020 was about $2.6 trillion, which implies that Apple’s valuation may have outpaced fundamentals. The firm is not immune to supply bottlenecks, has a maturing business, and sells expensive products that people can do without. Still, investors treat Apple stock as a safe haven asset akin to cash or gold, whilst also assigning it a price-earnings ratio of 31. Assuming no growth, that means you’d break even on an earnings basis in 31 years.
Granted, Apple’s rise has been extraordinary, it has some innovations in the pipeline (such as EVs, but then again, who isn’t getting into that market these days), and its moat appears wider than ever. Warren Buffett owns 5.4% of the company, and it occupies a massive 44% share of his (Berkshire Hathaway’s) portfolio - if that doesn’t signal conviction, what does? According to Bloomberg, Buffett’s profit on this investment is circling around $4 billion, with the total value of his stake at $125 billion.
However, Buffett didn’t establish the position at yesterday’s price and ‘no brainer’ investments don’t exist. In sum, history is rife with firms being perceived as untouchable, but few of them truly are. Apple may stay on top as a business, but its valuation will surely take a breather. Let’s see how this plays out.