Market Timing III
I thought the pandemic-fueled days of speculative excess were over, but the past few weeks have put that premature notion to rest. Just a few examples:
The return of meme stocks, like Bed Bath & Beyond. BBBY is up 21% YTD and at one point was up 108%, despite preparing to file for bankruptcy (which would likely render those shares worthless). AMC is up 45% YTD, has an enterprise value that is 50% higher than pre-pandemic levels and trades at 90x EBITDA.
ARK Innovation ETF (ARKK), a good proxy for unprofitable tech stocks, is up 22%. Tesla shares have seen record high net purchases as retail investors continue to “buy the dip.”
Bitcoin is up 39%, despite the cryptocurrency space becoming even more obviously ridden with scandal, potential fraud, bankruptcy and utter lack of utility. The founders of 3AC, who lost $3B of investor money and subsequently fled to countries with no extradition treaties with the US, are now attempting to raise $25MM to “fund an exchange to enable customers to trade claims against firms 3AC helped to bankrupt…The fact that 3AC was a major catalyst in kicking off the string of bankruptcies we saw throughout 2022 was not lost on observers, with Nic Carter of the Castle Island venture capital firm commenting that the endeavor ‘is akin to arsonists returning to the scene of the crime and offering to charge their victims for buckets of water’”
This is probably not behavior you see at the bottom of a market cycle.
More broadly, the market seems to be pricing in the following, relatively benign scenario:
Inflation will fall to 2% by the end of the year, a rate of decline that has only occurred 3 times in the past 75 years.
The Fed will begin lowering interest rates by the end of the year, despite repeatedly professing otherwise.
There will be a mild recession, if there is a recession at all. Yet “previous episodes of inflation suggest that it rarely falls as fast as markets are now forecasting that it will in the absence of a serious recession.”
Corporate profit margins will not only continue to exceed historic highs, but continue growing, despite a variety of pandemic related stimulus factors abating.
All of these happy scenarios are, of course, possible. But even if everything goes perfectly, the reward is a market that is still as overvalued as it was during the height of the dotcom bubble.
My brother pointed out a simple thought experiment that I think elegantly illustrates the current situation: suppose you think that there is a 50% chance of each of the four scenarios listed above playing out, and that the market is currently pricing for perfection.
The probability of all four events playing out favorably (assuming each event is independent, which is unlikely) is only 1/16th or 6.25%. Even if you assume that the events are dependent, the probability of success might only be as high as 50% (in other words, nobody knows what will happen).
So you are, at best, flipping a coin and, at worst, betting on two or three numbers at the roulette table, for the privilege of making your money back in the best case scenario (if valuations remain at peak dotcom bubble levels).
In other words, upside seems extremely limited at these prices levels, downside seems potentially vast, and the odds for success seem extremely low.
(This discussion above focuses more on general market levels, which I try to avoid thinking about, but lines up with what I am seeing in individual stock valuations)
Based on the above thinking, and despite the fact that most of the stocks I held still seemed marginally undervalued, I sold out of BKNG, GOOGL, AMZN, EBAY and USB earlier today. Although they all seem like solid companies, I am explicitly betting on the fact that I’ll probably be able to buy them again for a much lower price in the future. This is admittedly more speculative, but informed by the base rates of historical valuation and a subjective assessment on the psychology of bubbles and manias.
Currently, I only hold one micro/small-cap US stock, a handful of micro-caps in Asia and 83% cash. I’m still researching stocks daily, but will likely demand a higher margin of safety (probably somewhere in the range of 50% off instead of 25-30% off, even for good companies). Ideally, these companies would be less liquid and excluded from popular stock indices. The biggest risk is that prices will never reach obvious, bargain levels that I am willing to transact at, and that cash underperforms for a long period of time. But this demand for a greater margin of safety on purchase price reflects my greater uncertainty and skepticism about general market conditions, which I cannot ignore.
As always, this is not investment advice. I may change my mind at any time (as I did just in the past 2 weeks!) Most evidence points to the fact that it is impossible to time the market, and that it is better to “have time in the market” rather than try to “time the market.” Good luck.