Some Stocks Have Already Bottomed, But It’s Still Precarious

Stocks are down pre-market after huge up moves again yesterday, coming on top of the big up move we saw Monday which came after the big panicky sell-off last week. Fear finally got too extreme and the markets got set up nicely for at least a short-term bounce. As I’d noted late last week:

“With markets touching their crashed lows from a few weeks ago and with many, many stocks at new 52-week lows and with so many names down big and so few names up at all for days on end…

well, we’re finally getting some real fear built into the markets, though I’m not sure that excess fear can do much but help put in a short-term bottom…”

The markets, and each of the stocks I highlighted in the recent Trade Alert have popped big too with. I’d also written last week that:

“I’m locking in those profits on the hedges and am not planning on adding new put hedges unless the markets just completely rally here and the worst of the worst names go through the roof. The cycle of short-squeeze -to- panicky-long-sell-offs and back again is probably not over entirely.

I’m even doing a little bit of buying on the long side. Two new names I’m nibbling on (but just getting started!) and I’ll write up more on each in coming days if I hold onto these.

I’m starting a basket of Promising But Hated VC-Like stocks with two new names for now. I’ve started building small positions in WOLF and EVNX. ORGN is already one such name that I’d consider as fitting in this new basket. In the hedge fund, I also nibbled a little GOOG, MP, and U.”

People in the Trading With Cody Chat Room saw that I went in there on Thursday last week and posted:

“As you might expect, I nibbled a few of our longs in the hedge fund, including QCOM, ENVX, MP, SWAV, U with limit orders.”

WOLF is up about 10%, ENVX up almost 20%, GOOG up 4%, MP up 8%, U is up more than 10% since I sent out that Trade Alert last Monday. Each of those names are up even more from the lows they put in later in the week, of course, which is why I always suggest doing some scaling in when people get panicky and fearful and why I was doing so myself and posting about it in the Trading With Cody Chat Room. ADBE is also up 5-10% from its lows since I sent out the Trade Alert about starting to buy that one 12 days ago.

If you were too scared to buy at last week, I’d suggest doing a little selling right now to free up your nerves (and a little capital). I’ll be a buyer on the next leg down just as I was on the last leg down. Otherwise, for now I think the markets are a bit in no-man’s land and I plan to mostly sit tight for now.

Bigger picture, let’s talk markets and valuations. Here’s a part of the quarterly update letter that I’ll be sending to my hedge fund investors, starting with a flashback to a prior quarterly update letter from April earlier this year before the markets had completely tanked.

Back in the hedge fund quarterly update letter I sent out in the first quarter of this year, I wrote:

“The idea of investing in new platforms and technologies and innovations that create Revolutionary trillion dollar market places is just as valid today as it has ever been — but we had to let this crash in tech valuations play out in order to get the opportunities that will come as the future and the next cycle takes hold.

The question ahead of us right now is whether the markets correct too far to the downside in this crash and by how much if they do. I think that the crash will end abruptly at one point, but that it won’t be all instant upside in the broader markets and that many of these stocks out there trading down 90% from their (recent) all-time highs are never coming back.

I’ve spent a lot of time in the last few weeks studying business models, profit margins and growth potential for hundreds of wannabe Revolutionary stocks and have found a handful that are compelling and one or two that are truly looking cheap with lots of potential upside. The list of stocks that are starting to look like great investment opportunities is growing slowly and I expect to find several stocks amidst the rubble that can go up 10-100x in coming years. It’s in times like we are heading into that is when great fortunes are built.”

Note that bold that I added now. The fact is that none of this current market crash and economic crisis is surprising to us. We prepared for it by turning defensive, building up cash, adding to our shorts and put hedges before things got ugly because our analysis pointed us in that direction.

So that’s how we got here, now let’s talk about the here and now. When I analyze the market from the Top Down, like say looking at the S&P 500, things still look dire. That is, the analysts still believe that the S&P will grow earnings this year and that they’ll come out to about $220 or something for 2022. Take 10-30% off that for the likely earnings cut that some companies will have continue to take on margins (higher costs) and declining demand and you’ve got say $180 or so. The markets have been trading at an 18-20+ multiple on those earnings for the last couple decades while inflation was low and, more importantly for multiples, interest rates were extremely low. As interest rates rise, Treasuries and bonds and other debt becomes more competitive with stocks and people are willing to pay a lower multiple for those earnings. So lets’ say we should expect to a 15 to 16x multiple on those earnings (and that might even be generous if interest rates stay up here or even go higher). 15 to 16 x 180 = 3200 to 3380 for the S&P 500. It’s currently trading at 3790, which means that the S&P 500 could go another 15% lower and still be considered at about fair value.

But then again…

• When I go and analyze individual stocks that I like from the Bottom Up, I like what I see. Let’s use two names that I’ve recently started building up, Adobe and Shockwave. Shockwave isn’t at all like ADBE but it’s an interesting comparison so let’s look at the two. Shockwave has new biotechnology that will penetrate new markets and will be largely paid for by the government’s health care industry’s ridiculously favorable rules for companies like SWAV to make 85% gross margins. ADBE has software for its primary business which has almost no incremental costs whenever you bring on a new paying customer so they have 85% gross margins too (note that the market sets the price its willing to pay Adobe for its software vs how the government sets the price that its willing to pay for Shockwave).
  Anyway, Shockwave will grow 40% or more for the next few years as it penetrates new hospital systems and more doctors likely adopt its technology https://shockwavemedical.com/. Adobe will continue to grow high single digits or low double digits, call it 10%. So SWAV is trading at 17x 3 years out numbers which quickly drops to about 6x 5 years out numbers because of the high top line growth rate.
  ADBE’s aforementioned P/P ratio is 7x 3 years out which only drops a little more to 5x 5 years out numbers because the topline only changes 10% per year. So Shockwave is set up to become cheap in five years, but in the meantime it’s pretty expensive looking on any numbers you look at for the next 3 years. ADBE is just cheap now and will get cheaper but slowly.
• Likewise, when I look at the near-term economy with all its challenges including higher rates, inflation, Silicon Valley Depression, Russian/Ukraine war, supply chain crises, real estate and other assets still way overvalued in many ways and areas….the outlook is dire.
• But then again, when I think about how every major corporation has spent the last couple years figuring out how to make their supply chains more resilient and redundant by moving at least parts of their manufacturing to additional countries in Asia, Eastern Europe and Central/South America — and of course, Redomesticating much of the supply chain into the US itself…
• And how interest rates are already now close to natural levels for the first time in decades and how that’s healthy!
• And that the rate of inflation is probably already peaked, even if inflation itself probably isn’t going back to 2% this year or next…then again, it could, as those new improved redundant supply chains cut away at the global shortages and how inventories can go back to healthy levels themselves as prices are cut to clear the existing excess inventories in many sectors out…
• And how so many companies like Google, Meta and Adobe are finally rationalizing their employee base and are probably going to see wider operating margins in many sectors of their business as the overhiring phase is over probably forever…
• And how crypto is finally washing itself out and how so many of the silly, stupid and fraudulent cryptocurrencies are already down 90-99%…and how stocks, just as recently as last week when we followed our playbook and bought, were oversold and fear was everywhere and bears were bragging about how brilliant they’ve been and the bulls were deferring to them.

Our largest positions at the time of this writing include, in alphabetical order: GOOG, INTC, META, QCOM, RKLB, ROK, TSLA, UBER. For the first time in a long time, I covered almost all of our short positions as the markets collapsed into the end of the quarter, opening up some additional long exposure into the panicky action, as planned. I will judiciously look to add some more shorts and/or put hedges in coming days and weeks. I expect  individual stocks will stop trading so broadly in line and that stock picking, both on the long and short side is going to be more important for the next cycle than it has been for the last few years while so many stocks were going up and down together, in tandem.

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Cody back finishing up this post for Trading With Cody subscribers. Be careful out there. I do think some stocks have bottomed and/or are very close to bottoms that we’ll look back at in a few years and be glad that we were taking advantage of the broad sell-off. But we’ve already had this huge bounce off those recent lows and we should be prepared for more volatility and perhaps more downward bias in the path of least resistance.