Growth Stocks Get Overdue Market Correction in First Quarter
Thank heavens we finally got a correction in growth stocks during the first quarter. As painful as this sell-off has been for some positions, we badly needed to get some of the euphoric excess out of this market. The catalysts that have sparked the selloff are being attributed to a sharp rise in U.S. government bond yields (i.e., interest rates) and inflation expectations. The yield on the 10-year government note jumped dramatically in the first quarter – about 88% as of this writing from a low of .93% at the beginning of the year to around 1.75%. Folks, that’s big! This gets a bit wonky – so please forgive me – but the thinking is that growth companies are now worth less because their future earnings must be discounted at a higher rate. Perhaps. And I will admit that there is plenty more intellectual fun to be had by geeks like me with this discussion, but let’s set that aside for now.
The focus in most media circles has been on the “macro” factors – inflation, interest rates, government debt, etc. While these are certainly valid concerns, I believe that more attention will turn to earnings as the year goes on. Earnings estimates have been strong and rising. My hope is that investors will realize that solid management teams with great ideas are still going to make money for shareholders despite higher interest rates. The innovative themes that led the rally remain in place (i.e., robotics, artificial intelligence, genomics, battery storage, industrial innovation, 3D printing, cloud computing, mobile technology, etc.)
Now to the psychology part of this missive. Stocks are best used as long-term investments to accumulate wealth slowly over time – not as speculative, gambling devices. But when things get a little too good, people cannot stand the fear of missing out. Alas, a little euphoria tends to bring weak participants into markets. Human nature – as it always has been, and so it will ever be. These “investors” are generally the last ones to get in when things are good and the first ones to get out when trouble arises. You might say that stocks are then returned to their rightful owners! Based on market data, it appears that we are seeing this story play out again with growth stocks.
One of the managers in our investment models has been elevated to near rock-star status for her performance last year causing large amounts to flow into her fund at the beginning of the year. Moreover, websites have sprung up that mimic her trades as if everything she buys only goes up. This behavior is ridiculous and stupid – it’s a complete disregard of risk. Eventually Mr. Market is relentlessly efficient, and corrections send these sorts of “investors” back to the sidelines. And right on cue, her fund sold off hard beginning in mid-February.
I’ve also followed the stories in Gamestop and AMC with great interest and concern. They’re fascinating stories, and a lot of quick money was made and lost. Apps like Robinhood have brought in a new, younger generation of market participants who, uh-um, shall we say…seem to have some different attitudes towards investment risk. Ultimately, the broader participation should be positive for markets, but these new behaviors certainly appear to be causing some volatility in the short-term.
I know it’s never easy to watch certain stock positions go down, but please think of these times like you would when pruning a tree. By removing the dead branches, new and healthier growth will emerge. A more committed investor base should provide stocks a more stable foundation for longer-term potential growth moving forward.
Bottom Line: Stay patient, stay disciplined, and stay invested!