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Will stocks fall further? The consensus is Yes. Mr. Market is ornery. And ….

Mr. Market’s first trick is to panic us. He did it last week. Last week he pummeled our stocks ruthlessly. Then on Friday, he gave us a huge uptick. A magnificent day in the market — unless you’d been panicked into selling some of your heavy losers on Thursday. (As I did, because I was stupid and hence missed much of Friday’s gains.)

Going forward, what should we do with our stocks? There are “theories.” (I did a lot of reading on the weekend.)

First, we know inflation is high. Very high. And we know the Fed is raising interest rates and curbing liquidity in the economy.

So what happens then? The nine times since 1961 when the Fed raised rates to combat inflation, recessions followed all but one.

In short, odds are in favor of an upcoming recession — late this year or early next is the consensus — and hence more stock drops.

But which stocks are most vulnerable? First, we know that stocks with no earnings (i.e. losing money) are vulnerable. They’re already fallen dramatically. I’ve warned about them in recent months.

Second, what about  stocks with hugely high Price/Earnings Ratios? Historically, P/E ratios have been around 17 to 18.

I looked at some of our popular tech and energy stocks and put this chart together. You’ll note that the smallest losses over the last 52 week have been our energy stocks — e.g. Chevron (CVX), Devon (DVN) and Enbridge (ENB). Ironically, these three have hugely-high dividend yields — 3.45%, 7.86% and 6.18%.

Looking at the tech stocks, the biggest losses have been Amazon, Facebook, Microsoft, Nvidia and Tesla. They also sport high P/E ratios– even today. With one exception — Facebook.

Amazon is 51.71. Microsoft is 26.64. Nvidia is 42.05 (Ouch). And Tesla is 98.40 (double ouch).

Today tech stocks suffer in two ways: First, their high P/Es. Second, fundamental changes in their business. Amazon has been hit by the fact that its customers ebbed their buying from home (during the pandemic) and ramped up their “going out shopping” purchases. Amazon is now over-staffed and over-warehoused. That will take it a while for management to recover the business. Meantime, it’s losing money and its P/E in this chart (calculated by Fidelity) is far too high. Fortunately its AWS biz remains strong.

Netflix has come back to earth. But its business is still impacted by the zillion streaming video companies that entered that business in the last several years.

Not listed on this chart are the fintech companies which I’ve kept away from (i.e. not owned) because I see so little innovation — at least any that benefit me, as  customer.  Companies like SQ and PayPal have been total disasters in the last nine months or so. Even the “picks and shovels” of the crypto business not fared well. Coinbase (COIN), for example, is down 81% from its high last November.

So, how have stocks gone generally this year? An easy way to look at that is a heat map of 2022, so far:

There are patches of green among the sea of red — energy and some pharmaceuticals.

The more I write today’s blog, the more I tend to favor energy stocks. I really need to own more energy stocks and fewer technology stocks. Fortunately, I have pared my holdings down. I’ve updated the list on the web site. Click here.

I read much manystock market predictions over the past week — in between playing tennis.  The best I found is by John Cassidy in the New Yorker:

The Slow Crash on Wall Street Likely Isn’t Over Yet
As tens of millions of Americans watch the values of their retirement savings decline, many of them are asking what is causing the sell-off and when it will end.

After falling for six days in a row, U.S. financial markets rebounded on Friday, with all the major stock indices posting gains, and the Nasdaq enjoying its biggest rise in percentage terms—3.8 per cent—since November, 2020. Some beaten-up cryptocurrency assets also rose sharply, and the appearance of green on trading screens provided much-needed relief for investors. However, all of this needs to be put into perspective.

Even after Friday’s bounce, the Dow, the S. & P. 500, and the Nasdaq all closed down at least two per cent on the week. The Dow has fallen for seven weeks in a row, its longest losing streak since 1980, according to Reuters. If you look back further, the picture is even grimmer. In the past six months, the Nasdaq Composite has fallen twenty-six per cent, the S. & P. 500 is down fourteen per cent, and the Dow has slid eleven per cent. A lot of individual stocks have tumbled further: Netflix and Peloton are both down about seventy per cent.

Cryptocurrency assets have seen some of the biggest drops. Since last November, Bitcoin has halved in value, and Coinbase, a crypto exchange, has fallen nearly eighty per cent. Earlier his week, TerraUSD, a “stablecoin”—a cryptocurrency that’s backed by assets, including other cryptocurrencies—which is supposed to maintain a value of one dollar, fell as low as fourteen cents, and Luna, a cryptocurrency that is associated with Terra, lost virtually all its value.

Speculating in crypto has always been a pursuit for the intrepid or naïve. But, as tens of millions of American households watch the values of their more conservatively invested 401(k)s and other retirement accounts decline month after month, many of them are asking what is causing this slow crash and when it will end. The second question is harder to answer; the first one can be answered in three words: the Federal Reserve.

At the end of November, Jerome Powell, the Fed chair, signalled that the central bank was preparing to bear down on inflation, which had risen to a thirty-one-year high of 6.2 per cent. In March, after the Labor Department announced that inflation had hit a forty-year high of 7.9 per cent, the Fed raised the federal funds rate by a quarter of a percentage point and indicated that it could introduce as many as six more interest-rate hikes before the end of the year. Noting the mood at the March Fed meeting that raised the rate, Powell told reporters, “As I looked around the table at today’s meeting, I saw a committee that’s acutely aware of the need to return to price stability and determined to use our tools to do exactly that.”

There are at least two reasons that stocks tend to fall when interest rates are rising. The first one involves arithmetic. In theory, the value of a stock is determined by a formula that has future dividend payments (or cash flows) in the numerator and an interest rate in the denominator. When the denominator goes up, the value of the stock goes down. And what goes for individual stocks also goes for the entire market.

The second reason is a more practical one. By raising the cost of borrowing money to purchase houses, cars, and anything else, higher interest rates slow down the economy, and, in extreme cases, plunge it into a recession. A period of the Fed raising interest rates preceded four of the last five recessions: in 1981-82, 1990-91, 2001, and 2007-2009. (The exception is the recession of 2021, which was a consequence of the coronavirus shutdowns.) When investors saw the Fed commit to an open-ended series of interest-rate hikes, they had good reason to be alarmed.

Another reason for the slump in the market is psychological, and it may be the most important of all: investors have lost their security blanket. Despite the historical association between interest-rate rises and recessions, many professional investors had come to believe that the Fed would always have their backs—if the stock market ever got into serious trouble, the central bank would step in and prop things up. This reassuring belief acquired a name: the “Fed put.” (A put is a financial contract that grants an investor the right to sell a stock at a given price at some date in the future, thus limiting the downside.)

This faith in the Fed wasn’t based on wishful thinking. In 1998, Long-Term Capital Management, a giant hedge fund, got into trouble, and markets cratered. Under Alan Greenspan, a.k.a. the Maestro, the Fed orchestrated a Wall Street bailout of L.T.C.M., and the dot-com bubble inflated for another year and a half. During the global financial crisis, the Fed, with Ben Bernanke at its helm, slashed interest rates to nearly zero and enacted quantitative easing—creating trillions of dollars to buy financial assets, Treasury bonds mainly. In March, 2020, when the onset of the pandemic prompted another bout of panic-selling on Wall Street, the Fed quickly pulled out its playbook from the Great Recession. Between March 1, 2020, and December 1, 2021, the Nasdaq doubled, meme stocks flared into the sky like fireworks , and the value of Bitcoin rose sixfold.

Many investors are concerned that the Fed put has now been withdrawn. As Powell and his colleagues have reversed course on interest rates and quantitative easing—next month, the Fed will start selling some of the securities it bought in recent years—their language has also changed dramatically. As of late, Powell has repeatedly said that he would welcome “tighter monetary policy”; this statement can be roughly translated to mean higher loan rates and a lower stock market. Last week, he said, at a press conference, “We need to look around and keep going if we don’t see that financial conditions have tightened adequately”; this could be interpreted to mean that the Fed thinks the market needs to fall further.

How much further? Quite a ways if stock-price valuations were to revert to historical norms. Take the price-to-earnings ratio, a commonly used valuation metric. For the S. & P. 500, the average price-to-earnings, or P/E, ratio going back to 1880 is about sixteen. Even after the recent falls in the market, the P/E ratio currently stands at about twenty. That discrepancy suggests stocks could fall another twenty per cent. However, history also tells us that markets often overshoot on the way down as they do on the way up, suggesting that an even bigger decline might be coming.

Of course, nobody can be certain of what will happen, and hope springs eternal. Friday’s bounce reflected a “buy on the dip” mentality that has become ingrained. But, as long as the Fed is on the offensive against inflation, ordinary investors should be cautious. In any period of rising interest rates and volatile markets, there is a danger that something can snap and spark a fast crash. The gyrations of TerraUSD, together with the collapse of Luna, provided an illustration. In all likelihood, the sums lost in this particular debacle weren’t sufficient to threaten the broader financial system. But it was a timely reminder of what an old-fashioned fast crash looks like.

Should abortion be legal?

Here is a good summary of the pro and con arguments. Click here

See what you’re missing because you’re poor

From Condé Nast Traveler:

These First Class Airplane Seats Are as Decadent As It Gets
From in-flight showers to video chats with flight attendants, here’s what you could be enjoying at 30,000 feet.

Click here.

These things are better than stocks

We planted them all. Now look at them.

Allergy season is here, with a vengeance

My daughter wakes up to a car covered in yellow gunk. It’s called pollen. She and her kids can’t stop sneezing. Half my friends think they’re caught covid.

The best trick is to wash your face in cold water every hour. Stay away from the great outdoors.

You could also take one of these each day the allergy season is raging, as now.

Putin dies

Putin dies and goes to hell, but after a while, he is given a day off for good behavior.
He goes to Moscow, enters a bar, orders a drink, and asks the bartender:
Is Crimea ours?
Yes, it is.
And the Donbas?
Also ours.
And Kyiv?
We got that too.
Satisfied, Putin drinks, and asks:
That’s great news. How much do I owe you?
5 euros.

This week

The health of the consumer will be a major focus this week. The economic calendar includes April retail sales and also a look at the housing sector, with the National Association of Home Builders’ survey; both reports are set for release Tuesday, with housing starts coming on Wednesday and existing home sales Thursday.

Of course, all these reports are irrelevant given that the one factor affecting the health of our stocks — namely the Fed. They’ve still got a long way to go with interest rate hike and clobbering the inflation. Downward pressures are with us for a while.

If all this picking stocks bores you (or gives you agita), buy yourself an index fund. Here’s three of them over the last five years. VGT is tech stocks. SPY and VTI reflect the S&P 500.

— See you tomorrow, or so. — Harry Newton