Cboe Volatility Index (VIX), real-time index representing the market’s expectations for volatility over the coming 30 days, currently sits at 16.48. Generally speaking, this means markets are more or less stable: we are far from the elevated levels of 30 and above that signify high volatility.
VIX Index Chart 2020-2021 (Source: Trading View)So, markets are calm but the question is “should we feel calm too?” I personally think the answer to this question is a strong No!
So, markets are calm but the question is “should we feel calm too?”
There are at least 5 key factors coming to mind that are and will continue to impact the stock markets and not in a way that causes price appreciation. These factors include:
- Natural disasters such as hurricane Ida and their effects
- Increasing level of inflation
- COVID-19 and its crippling effect on select industries
- Housing eviction issues and their impact on spending
- And lastly, the Afghanistan exit, issues surrounding it, and its short-term as well as long-term implications for global terrorism.
These factors defer from one another in terms of the type of impact they have on the markets (acute vs. long-term), as well as the magnitude of their effect.
Effects of hurricane Ida, for example, are more transitory: prior to the hurricane, nearly 300 offshore platforms — or half the manned platforms in the Gulf of Mexico — were evacuated ahead of the storm.
A more serious area of concern is the refineries. Louisiana’s 17 oil refineries account for nearly one-fifth of the nation’s refining capacity.
Potential damages, assessing those damages after the storm and restarting the operations takes time and this will cause potential delays in supply of crude oil or gasoline. Having said that, gasoline prices, if impacted, could return to pre-storm levels in one to three weeks once the capacity comes back online.
[Institutional investors] are nervous about Delta variant of COVID-19 and are flocking into large cap tech names with sustained earning power.
Inflation and housing issues, however, are more serious matters: S&P 500, for example, made 11 new highs in the month of August. This is something that has not happened in the stock market since 1929.
Such a development at least shows that there is a large amount of liquidity in the market and there is high appetite for stocks (at least for the big tech names that constitute 21% of S&P 500).
Institutional investors are not blind to the risks mentioned above: S&P making new highs is partly because this group of investors are nervous about the potential impact of Delta variant of COVID-19 and are flocking into large cap tech names such as Apple of Google as they consider them stocks with sustained earning power in this environment.
In this regard, longtime value investor Scott Black’s take on the market is very interesting and is worth checking out (watch the video below).
Feeling nervous about anything but large cap tech players is not a crazy thought: When it comes to inflation, its rise will lead to spending power decrease and that’s bad news for the stocks.
Furthermore, with U.S. Supreme Court ending CDC’s pandemic residential eviction moratorium, we may witness a spike a number of homeless people soon and that in turn will depress the consumer spending.
Some of these events, however, might never happen: this is common knowledge among many professional or semi-professional investors. If we have learned one thing about the stock market history, it’s that we can’t really forecast the future precisely and accurately.
Instead, I prefer spending time looking for bargain stocks. In taking this course of action, at least we know we will be making money sooner or later. The key here is to resist the urge to buy stocks that are “hot” but lack quality or are expensive.
Speaking of the process for finding “cheap companies”, I’ve found Scott Black’s search criteria to be very useful:
- Companies with high return on equity.
- Strong (and stable) cash flow.
- Sustainable earning power.
His recent pick, ICHR, is a company that makes components for manufacturing of semiconductor products. It’s flush with cash and has stable revenues; thanks to long-term contracts with customers such as ASML that have strong secular growth.
Furthermore, ICHR has been trading with a forward P/E multiple of around 10: this is low compared to S&P 500’s average of around 22 and Russel 2000’s average of around 20. In a nutshell, this is a good purchase with a good price tag.
Contrast ICHR with Shopify (SHOP) that has a high ROE (30.80%) but a forward P/E multiple of 239.39. there is no question that this is a good company but is it a bargain? Perhaps not. Furthermore, although digital commerce is a strong secular trend in the years to come, who can guarantee that Shopify will continue to be a strong part of it?
Even the mid-term appreciation in price of this stock is not a sure conclusion (a hot stock like Tesla has been losing money YTD).
Holding such stocks to me seems like being a cowboy being in a rodeo: it’s fun while you’re doing the riding, but boy it hurts if you fall!
We witness the same type of swings and uncertainty in the crypto markets especially in the last couple of months: In uncertain times like this, instead of competing in a rodeo (so to speak), having some cash available to do bargain hunting is a more prudent course of action.
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