The stock market sell-off has continued to rock Wall Street and the Nasdaq has continued to shed-off more weight everyday as the world’s largest economy inches closer into recession. The De-Risking phenomenon as broadly at play due to several factors as investors move their funds out of the New Economy stocks into high value stocks and bonds. Tech stocks has suffered the most since the onset of 2H22, with the Nasdaq down by a massive -33.96% from the December peak at 16626,90. Tech stocks have endured a rough time as forecasted earnings and revenue for the last half of the year remain gloomy. U.S. GDP growth rate was down to 1.8% in June, in contrast to 12.5% during the same period last year. As Aggregate Demand continue to tank amidst escalating global energy prices, high growth stocks are facing a daunting task of attracting investors in such an environment.
The trade-off between high growth stocks and value stocks has become magnified in such an environment as investors opt for revenue in the form of earnings instead of future promises of earnings as proposed by high growth stocks. If the economic outlook remains downcast, with several analysts expecting the U.S. economy to sink into a sustained technical recession commencing in 1Q23, stock market rotation will remain at play until then. Nasdaq stocks are currently bearing the highest risk because of the mammoth discrepancy between the stock prices and earnings per share, before even bringing in the issue of revenue into the loop of analysis.
In 1H22, Netflix one of the prominent New Economy stocks missed its forecasted Revenue by more than a billion dollars. The estimated revenue stood at $8.026B but the actual figure rested on $7.97B, which happened to be $3.355B less than the Revenue of the beverages giant Coca-Cola Company. The beverages colossal represents the prominent high value stocks on Wall Street despite trading significantly at much lower stock price than Netflix. With a reasonable stock price of $56.02, Coca-Cola trades close to 420% less than Netflix’s massive price tag of $235.44 per share. In terms of YoY gains, Netflix is -66.39% down from its November 2021 peak at $701.34 per share whilst Coca-Cola is up +6.64% during the same period. As Recession rhetoric gets loader and real, confirmed by worsening macroeconomic metrics, high growth stocks are prone to further stock price fatalities. If the downturn eventually eclipses the entire market, high value stocks will decline but at a slower rate as compared to the New Economy stocks.
The discrepancy between high growth and high value stocks can be summarised in the behaviour of the two major indices on Wall Street, which are Dow Jones (DJI) and Nasdaq. DJI is more of a representative of the high value stocks rather the health of the entire U.S. economy which is better demarcated by the S&P500. The DJI is down -20.72% from its peak in January of 2022 whilst the Nasdaq is down -33.08% for the same period reflecting the speed at which high growth stocks are being churned out of investors’ portfolios.
Funds might be migrating out of high growth stocks into Dividend Kings as well, since they are the bound to offer dividend even in the midst of recession because of their solid fundamentals. Dividend Kings are not necessarily members of any of the major indices but they have managed a dividend growth payout streak extending for at least 50 years. Chiefly among them being Coca-Cola (KO), Procter & Gamble (PG) (a tried and tested recession resistant stock), Dover Corporation (DOV), the little known Stepan Company (SCL) with a streak of 54 years, and the list goes on to include a variety of industrials companies. Its no surprise there are no high growth stocks within the ranks of the Dividend Kings.
As funds move out of high growth stocks, investors might opt not to move funds entirely out of the stock market but rather change the stock composition of their respective portfolios. Injecting more value stocks to counter the rapid decline in value and dividend of high growth stocks. De-risking in such a vogue will not necessarily eliminate the risk associated with the stock market but rather shift it from one high risk spectrum to more stable spectrum. It works well to the advantage of the portfolio because value stocks normally manage to generate revenue, therefore earnings and dividends in mild recessions.
Funds can be entirely rotated out of stocks into bonds or even foreign markets. The Federal Reserve embarked on a rate hiking procession, an emphatic bid to rein down inflation which is currently standing at 8%, a 40-year record mark. At 3% – 3.25%, the Federal Funds Rate is stimulating a possible stampede out of stocks into Federal Bonds especially the much-coveted U.S. Treasury Bonds along with other Municipal bonds. Cash has become even an asset of choice for the more risk averse investors especially Pensions funds. The Fed is poised to announce another rate hike in 1Q23 to take the interest rate to 4%-4.45%, triggering massive Dollar strength in the process. Mary Daly, the President of the San Francisco Federal Reserve Bank is actually more hawkish, expecting a rate hike into region of 4.5%-5% and to remain at that elevated sphere until the end of 2023. This is derived from her recent comments in regards to how the Fed is determined to tighten the monetary policy for as long as possible in a bid to strangle inflation back to the 2% target.
The DXY is trading at decades high level (112.173, a 27.53% accumulation from the 2021 lows at the 89.932 handle) against its contemporaries as the Interest Differential effect propelled the Greenback beyond the 100-peg, strangling the decapitated Euro in the process. As the demand for U.S. bonds escalates across the globe in pursuit of attractive yields across the Atlantic, the Dollar continues to gain, awarding U.S. investors the opportunity to invest cheaply in foreign bonds and stock markets.
The de-risking on Wall Street might come as a benefit for other international stock markets as it has become relatively economical for U.S. investors to invest in those markets riding on the back of the upbeat Greenback. The Euro (EURUSD) slumped to trade at 0.9542, that is below parity for the first time since 2002 against the Dollar, whilst British Pound (GBPUSD) got pummeled to trade at 1.0370 (another historical handle) for the first time since 1985.
