The Buyers are Back! Your Money May 27th 2022

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This week epitomizes the adage that investors should focus on “time in the market” rather than “timing the market”. When markets snap back they tend to do so in a very vigorous fashion and this week was no different. Mind you, the most recent slide was one of the worst in my 39 odd years in the business. I am still shocked from the carnage the took place last week when a bell weather retailer Target plummeted 25% in one day. However, it could be a symptom of a bigger problem. I suspect Exchange Traded Funds (ETF’S) which now dominate the marketplace provide investors with a high degree of liquidity without regard to the other side of the trade.

ETF’s were created to provide institutional investors with the ability to enter or exit a specific part of market place. If an investment manager wanted to switch $1 billion from their bond portfolio and put it into the S&P500, instead of putting in 500 trades, one for each security in the index, they could instead purchase an ETF that would own an identical portfolio of the S&P500 through the ETF. Fast, simple, effective. Until you think about the counter trade, in this case the manufacturer of the ETF like Blackrock or State Street. If you are buying, then one of them are selling which means they have to enter into the stock market to buy all of the S&P stocks in the index ETF they just sold. In an orderly market it is not a problem because its fully automated by computers constantly adding or subtracting their net holdings.

However, when markets become just a little illiquid, there is no one standing on the sidelines to provide support. In fact, I suspect active portfolio managers are now taking advantage of the price swings knowing the arbitrage computers don’t wait for a bid, they sell at market regardless of the price. The smart ones just have to wait until the carnage rips through the market and then they enter to sop up beaten down stocks. When I started in the industry and a stock got a downgrade or earnings miss, the traders on the floor would come together and match up the buyers and sellers in the book before opening a stock. It still might open down 25% but that was a rare exception in my experience (junior resource stocks not included).

Now, In the case of Target, it has finally regained some of the dip with a 10% bounce, but it is still trading at only 15 times earnings and pays a 2.1% dividend. We are not buying retail right now because we are not convinced the inflation cycle is over and if wage costs continue to build, margins will be negatively impacted. However, Target management is top notch and we would not count them out. A quick look at their balance sheet tells the story. Sales were up year over year, but cost of sales was up even more. That tells me their supply lines have been significantly impacted by the factories shut down in China and the back log at container ports. On the other hand, their inventory on hand was up nearly 30% over last year which points to a potential swoosh (a swing and a miss at home plate).  Or maybe, the bulk of their holiday inventory did not arrive until January and by that time the consumers were tapped out. Regardless, we suspect management will not be sitting on their hands waiting for some miracle, they will be pushing it out at fire sale prices if necessary.

So, what else drove markets higher and is this the beginning of the bull market or a just a bear market rally? My gut tells me the pain is not over. Yes, the bounce was spectacular but with markets completely oversold, a snap back was overdue. Thematically, we still feel energy stocks are in a bull market not withstanding the near socialist decision by the UK to tax energy profits at 25%. Let us hope the rocket scientists in Ottawa, don’t emulate that one, it would kill any hope of Alberta bringing the country out of a possible recession. The US reported Q1 GDP at -1.5% this week with the inflation deflator still at 8%, and it does not look like the second quarter will be much better with skyrocketing gasoline prices eating into consumer’s disposable income on both sides of the border. And don’t look for any relief from central banks either. They recognized they kept the liquidity taps open for too long last year, allowing for the inflation cat to get out of the bag with a vengeance and now they must engineer a soft landing. However, both bond and stock markets have already done a lot of the heavy lifting…well that and the collapse in some of the crypto coins this month.

The hot housing market has quickly cooled especially with first time home buyers seeing their entry fee going significantly higher, and therefore removing some from the equation. Meanwhile if we look at stock market indices, they are not telling the whole story.  Year to date the Dow is only down 8.6% and the TSX is off only 2.2%. Trouble is very few people own the index. A lot of them, and I suspect many newbies, jumped on the high flying technology and meme stocks, instead of boring bank, telecom and utilities. Nope, they drank the koolaide and believed the bulletin board hype that covid created a new paradigm of investing. Remember last year when Shopify had a market capitalization greater than the Royal Bank? It is now in about 15th position and still seems to be falling. Perhaps it’s a bit of sour grapes because I did not buy it as it soared from $600 to $2200. Mind you it is $469, so do the math for those that bought it over $2000 per share.

This week I mentioned Lightspeed as one of the top performing TSX stocks as it bounced 11% to $33, but then again it was trading at $165 about nine months ago. My point, is I suspect a lot of newbie investors have seen more thana 2.2% drop in their portfolio over the last nine months and the associated negative wealth impact will likely curtail spending much faster than anything a central bank can do vis a vis interest rate increases and bond liquidations from their overall holdings.

We are starting to create a list of oversold stocks and feel there will be some good entry points this summer. That holds true for bond investors as well. We forgot to mention that the first five months of this year has been the worst we have seen in several decades.

Stay tuned…stay safe and Happy trading.

Cheers Steve.

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Steve Bokor

Steve Bokor

Portfolio Manager