MARKET CORRECTION: WHEN WILL IT RECOVER?

March 2021 has seen many growth stock’s valuation dropping. In this article, we will be covering the reason, whether should an investor HODL, or sell.

First reason: US 10 Year Treasury Bond Yield

US 10 year treasury note yield has hit an 1 year all time high of 1.6% at the time of writing from a mere 0.9% at the start of the year. This represents a 70 basis points increase in a timespan of just 3 months.

With the backdrop in mind, it is important why the yield on the 10 year note matters. Financial institutions and funds alike use the 10 year note as a proxy for mortgage rates, interest rates, to gauge inflation and many more. The increase in yield have caused a shift in investing focus and sector rotation of growth stocks to value stocks, and this is why tech stocks, which many of them are in the explosive growth period such as the EV industry is hit the hardest especially.

The reason for this is because higher bond market interest rates would reduce the value of future earnings for growth stocks. Growth stocks tend to enjoy high Price-to-Earnings (PE) ratio as the valuation is coming mostly from its ability to generate cash flow in the future, also known as the future value (FV). When interest rates goes up, the discount rate which is used to discount the future value to growth stock’s current value increases as well. This leads to a lower present value, which is then reflected in the current stock price of growth stocks. Citing an simplified example from Barron’s, for every 1% rise in interest rates, Tesla’s value will be hurt by $200 billion, or 25% of a $800 stock price target.

Second reason: Fear of big tech’s valuation

Nasdaq is up 43.6% alone in year 2020, its biggest annual gain in 11 years since year 2009, right after the Great Financial Crisis. We have seen doomsday analyst screaming for a market correction as big techs valuations does not reflect the true GDP growth of the US economy due to the COVID-19 pandemic. Indeed, year 2020 have been a wild ride. Apple crossing the 2 trillion valuation mark, Tesla went up by a whopping 695% and Nio flew to the moon by rising 1,100%, just to name a few.

Finally, we have reached the million dollar question. Should you sell your stocks to cut loss? Will it dip even more? We will be discussing the following few points below before coming up with a conclusion.

US 1.9 Trillion stimulus package

As we all know, the US is rolling out a third stimulus package soon, valued at US 1.9 trillion dollars by the Biden administration. With U.S. Democrats securing unified control of the House of Representatives and Senate, we believe that the stimulus package will be implemented. The House is scheduled to vote on Tuesday, the 9th of March on the terms for the bill’s consideration. We expect that the vote is will be passed on a party line, as it did in the Senate, with a narrow Democratic majority. Once passed and signed by President Joe Biden, it will increase the amount of M2 money in the US, of which it will eventually flow into the stock market and will definitely contribute to another wave of frenzy buying, pushing stocks to yet another all time high. A timeline that the world are looking at is before the 19th of March, when benefits from the second stimulus package is set to end.

Unemployment Rate & Manufacturing data

In the latest month of unemployment rate data, it is evident that the US economy is recovering. Unemployment rates has hit 6.2% and non-farm payrolls increased by 379,000 at the end of Feb 2021, the lowest in a year. The jobs report has set an extremely positive tone as the pace of COVID-19 vaccinations accelerates. While the labor market still has a lot of ground to make up, the US. economy is in a different place than a year ago and the economy seems poised for a strong rebound this year with predictions of economic growth in the first quarter alone could hit 10%, according to a Federal Reserve tracker.

Also, Manufacturing data for Feb 2021 showed the sector at its highest growth level since August 2018. That report from the Institute for Supply Management in turn helped confirm the notion among economists that output to start the year is far better than the low single-digit growth many had been predicting in late 2020.

No fundamental change in big tech, growth companies

There have been no fundamental change in the business of many of these growth stocks that have suffered a major correction. One philosophy that Pivotal believe is doing your own due diligence. If the company you bought is fundamentally strong, this correction is the best time to dollar cost average. In fact, investors with exposure in growth stocks, particularly speculative stocks should be happy as a correction at this scale is actually healthy comparing to the all-out crash during the dot-com bubble. It’s easier said than done, but just like what Warren Buffet said: “Be fearful when others are greedy, and greedy when others are fearful.”, it takes strong conviction to hold the stock that you own amid these challenging times.

In summary, we believe that this correction is healthy and will soon be just another correction like the many ones that we have seen, and definitely more to come in the future. If you believe in the company that you bought, done your due diligence and have strong conviction in it, this will just be another storm, a golden opportunity to buy the dip. Just like all corrections and market crash in the past, it will eventually past and markets will continue to make all time highs.

On the contrary, if you do not know what you are buying but simply by just hear-say, following so called “gurus” and have no idea what the business is about, it might be a better idea to sell, move on and rethink your investing strategy.

Disclaimer: This article is for education purpose only and does not constitute to any financial advice. The writers have position in growth companies.