A Few Thoughts About the Market and Current Downside Volatility

Last month we provided a video update on our views about the market and the economy. I know many of you have watched this and we are providing it again if you would like to review the information. The link is here.

https://destinationwm.wistia.com/medias/w4gka97v76

We have transcribed a portion of it for you below. In these partial excerpts our goal is to talk about what’s happening in the market and why equity and fixed income prices have been under pressure.

We will continue to provide additional transcribed portions of the discussion in future updates.

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“So, let's go ahead and get started, and talk a little bit about what's happening in the world today. So I don't need to tell you that the market's been going down. The S&P 500 obviously is down right about 20%. It's bounced back a little bit. I believe as of today, it's down about 19 or 20% as opposed to 21 and 0.6%, which was last week.
 
But obviously the market's down. And this qualifies as what we call a bear market. A bear market is a market that is down at least 20%. And this certainly does qualify. The NASDAQ, as you probably know, is down even more than this. Which is more of a tech-oriented sort of index. So obviously equities have been under significant pressure, something we've seen before. People forget that in the beginning outbreak of COVID, markets were down much more than they currently are down and came roaring back.
 
Also what is also down is the bond market. So, the bond market is down if you look at the aggregate bond market, and the aggregate bond market is generally a higher duration or maturity than the type of assets that we utilize in portfolios, but it just really captures the overall bond market.
 
It's down about 11% because of what's been happening with expectations with inflation, as well as what the Federal Reserve has been doing in portfolio strategies. So obviously we're facing some challenges when you have not only equities and fixed income markets going down. And I wanted to talk for just a moment about why there is a downturn, and what we think is going to have to change for there not to be such a big downturn.
 
First of all, valuations were fairly stretched. I think it's fair to say they were fairly stretched because of just a rapid increase in the price of assets. In particular, speculative assets were quite stretched. There's something called SPAC, S-P-A-C, which is a special acquisition company. Which really went out, these entities would go out, raise money, and they would tell people, give us the money. And then we'll figure out how to invest the money.
 
So, you may say, well, who would ever do that? Well, people who are looking to try to find the next X, Y, or Z meteoric stock are doing that. Now, of course, these specs have since kind of tumbled rather precipitously. And in fact, depending on what numbers you look at, some of these assets are down anywhere from 40 to 50, 60% in some cases. And that's not just SPACS, or these special acquisition companies. Companies that have challenging earnings, a lot of cloud-based companies for example, are down significant amounts.
 
And this is not terribly surprising, I think, given the rapid run up. A company that makes no profit, that is valued at billions and billions of dollars, you have to have a pretty strong conviction that at some point, that company is going to make profit. And what the market is essentially saying is, is that there is no strong conviction for many of these names.
 
We think every time, or I guess we hope every time, there's a little bit more knowledge and learning that happens. But nah, good times go on for a little while and people kind of forget about risk until all of a sudden they remember valuations matter. And when they remember, this is what happens. Things tend to fall fairly quickly.
 
And everybody acts as if they're shocked. But I'll give you an example. And I won't use any specific names. Some of these new car acquisition companies, that are actually buying and selling cars online. The standard dealership model is that you take a car in for X minus 10% of what you think you can sell it for, and then you sell it for a 10% profit. Profit. That's the standard model.
 
What many of you probably don't realize is all these ads you see on TV about companies that will buy your car online, which I've personally done this myself with these companies. What's really interesting is many of these companies end up selling cars, are you ready for this, at a loss. So they buy the car and then they sell the car actually at a loss. You may say, now, how can they possibly do that?
 
The way they do that is they've gone out and raised all of this very, very cheap money that has all flooded into their coffers, to really help subsidize them as they lose money, to be able to stay afloat. Well what's happening, going to the second point, is interest rates are going up. On concerns about inflation.
 
Which means when interest rates go up, these companies that are highly valued because they had access to cheap money, so they could operate at a loss, are now going to be cut off from that cheap money. And if that's the case, what does that mean for their business model when their business model is selling things at a loss?
 
So concerns about inflation are not only driving bond prices down, but they're driving more speculative assets. And even in some cases, technology assets lower because people are concerned about inflation. And because people are concerned about inflation, the federal reserve has taken action.”

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Source: https://destinationwm.wistia.com/medias/w4gka97v76