Anyone who was paying attention to stock markets in January watched just about everything get taken to the woodshed day after day. Up until the final two trading days of the month we were on pace for the worst start to the year, ever. At one point, the Nasdaq was looking like January 2022 could be one of the FIVE worst months EVER for the index – that includes the start of the pandemic, the 2008-09 financial crisis and even the 2000-01 dot com bust. Think about that for a second – a month in which not much of anything happened, people couldn’t sell their growth stocks fast enough! But why? What the heck just happened?? I have some thoughts …

INFLATION?

Inflation can be painful for real people and a major problem for central banks as most have a mandate that includes maintaining a *healthy* amount of inflation in the system. Energy has been a large contributor to inflation which is why energy stocks were one of the few safe spaces for investors since the start of the year. By and large, companies that are selling things that customers want will have ‘pricing power’ or the ability to pass along higher costs, yet many of these companies took it on the chin along with the others. Technology is generally thought to be deflationary, so logic might tell you that companies that are anti-inflation, might actually hang in there just fine in the face of inflation, but that clearly hasn’t happened either. Technology has just been leading all the way down. The best tool that policy makers have traditionally had and used to tackle inflation has been raising interest rates, so as long as inflation remains a symptom, higher interest rates will be a treatment option – generally speaking, stocks prefer lower interest rates to higher rates (more on this in a minute).

VALUATIONS?

Stocks were expensive! When you hear your financial advisor or a talking head on TV say that stocks are expensive, what they mean is that you are paying a lot today (compared to other companies or historical averages) for a future dollar of sales (we use this one a lot for companies that don’t make profits right now) or profits for companies that have them. If your advisor wants to sound extra smart they might comment on whether stocks are expensive based on how fast those sales or profits are growing. But I digress … stocks have been expensive before and have stayed expensive for a long time or gone up even more, so we know that stock prices don’t just drop because they are considered expensive.

Unfortunately for people like me, on a day to day or week to week basis stocks don’t trade on the ‘fair value’ that our spreadsheets kick out (good research is a long term investing tool). Stocks trade on sentiment and shorter term expectations and more often than not the best story wins – when the story is good enough, more people buy in and prices will trend higher. The flip side of that is when the story shows some inconsistencies and people start asking hard questions. The trend can flip and build steam of its own – often times the downturns are quicker and more vicious than the uptrends, and they can also raise questions about other companies as a result. When answering the question What if I’m wrong? the stakes are much, much higher when stock prices are headed south. The rollover in big technology stocks started in November, picked up steam through January, as investors started to re-think the answer to that question and sentiment shifted.

INTEREST RATES?

Stocks can go up when interest rates are at 0.25%, 2.50% or 5.00%. Stocks can go up when interest rates are moving lower or higher. Investors are resilient when it comes to interest rates, all things considered. On a very fundamental level, higher interest rates mean that future sales, future earnings and future growth are worth less today than they otherwise would be with the same or lower rates. Ask just about anyone in the investments world where are interest rates headed? You will find something close to a consensus that the direction will be higher – higher because inflation is running hot, higher because economies of most developed countries are generally doing okay. Higher because the rationale for emergency low rates has subsided, higher so they can be moved lower later if needed. The question beyond ‘higher’ is how high or how fast and whether those changes will cause other problems along the way.

UNCERTAINTY?

Uncertainty is just another word for risk and when we invest in stocks what we are actually doing is putting a price on trading risk with other people based on our appetite and our outlook for an uncertain future – for a company, a country, a resource, the market overall, anything. Sometimes we want more risk, sometimes less but there is almost always someone willing to take the other side of that trade for you … for the right price. Uncertainty brings together all the other ideas I mentioned above – but until we know what’s happening with inflation, and how policy makers will react with interest rate moves, we can’t determine how to properly value companies today and what story will win to push prices higher or lower.

I don’t recall a time in recent memory when I have seen so many differing views on the path and destination levels for interest rate moves, whether that’s from the Bank of Canada or The Federal Reserve in the United States. What this means for stocks is that, with so much uncertainty and differing views, everyone is having trouble coming up with a fair value today for those future sales, profits and growth … That’s a recipe for finding a fair value that is lower and that happens quickly because the stakes were pretty high for the answer to the question - what if I’m wrong?

The good news for long term investors is that market moves like these are healthy, normal and are the reason we invest for the long term. Stocks can’t go up if they don’t sometimes go down – if there was no risk, there would be no reasonable expectations of earning a return. Unfortunately, until we get closer to some consensus about where rates are headed and what other policy changes will be made, there is going to be a lot of uncertainty floating around. We are likely to stay in a bumpy period, so pick your spots accordingly. I have little doubt that in hindsight (a year or two or five from now) people will be kicking themselves for having passed on the opportunity to buy some stocks at a deep discounts today.