The higher you rise, the more painful the fall. This is generally true in life and certainly true for many high-flying stocks, and especially those that are loss-making and trading on lofty expectations and valuations.
Case in point: Cloud software stocks as a group were hit hard the previous week. The selloff was triggered by weaker-than-expected 4Q2021 guidance by a market darling, DocuSign. Its shares were routed on Dec 3, falling by a whopping 42%, which wiped US$19.4 billion ($26.5 billion) off its market cap. The stock has rallied strongly during the pandemic on expectations of robust growth but the company has yet to turn a profit. It was trading at almost 24 times trailing sales — yes, sales revenue, not profits — right before the selloff.
Shares in Adobe also came under intense selling pressure, by association. It was the worst-performing Standard & Poor’s 500 stock on that same day — but the drop, while a steep 8% in a single day, was far milder by comparison. Plus, it has since recovered nearly all lost ground. Adobe shares are not exactly cheap either — priced at 47 times forward earnings — but it is part of the smaller group of cloud software companies that are actually profitable.
The point we are trying to make is this: In a broad-based stock market selloff, few, if any, stocks will escape unscathed. But there will be varying degrees of losses. And this makes all the difference when it comes to portfolio management.
We have previously explained why we should stay invested at all times. History has proven that it does not pay to try to time the market. No one can consistently and accurately predict market inflection points. Therefore, sitting on the sidelines waiting for the right timing is but a fool’s errand. But that does not mean we do nothing either. We can decide to rotate between sectors and countries, taking into account macroeconomic factors. We can shift from more aggressive to less aggressive to defensive, and vice versa, with a diversified portfolio. Managing risks is as important, if not more so.
Most analysts and investors agree that US stocks are trading at historically high valuations currently, based on all traditional valuation metrics. Stock prices are driven by unprecedented liquidity, low interest rates and negative real returns on the entire Treasury yield curve. There are many that believe a major correction is imminent. Indeed, although markets, as a whole, are generally efficient, there will always be pockets where extreme frothy valuations and irrationality prevails — for example, meme stocks with little fundamental basis, over-hyped electric vehicle companies yet to commercially produce any vehicles, cryptocurrencies of no practical utility and the mania surrounding non-fungible tokens (NFTs).
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Cryptos and NFTs are closely related to the latest hype, the metaverse, which is further fuelled by Facebook’s recent name change to Meta. We think much of this is due to certain parties trying to “manage” the marginal price to inflate the “values of their inventories”. We will write about the fallacy of marginal pricing in capital market valuations in the future.
Simplistically, the metaverse is an interactive, centralised virtual world where people socialise and conduct business activities, typically via virtual reality and augmented reality devices. The metaverse has attracted huge amounts of investment dollars worth hundreds of millions — in real money — and growing. New York-based Republic Realm recently announced that it spent a record-breaking US$4.3 million on digital land acquired through The Sandbox. Prior to this, Canadian crypto company Tokens.com Corp splurged US$2.4 million to purchase a plot of virtual land on rival platform, Decentraland. A Gucci handbag was sold on the Roblox platform for more than the real version. Even Nike is reportedly planning to sell virtual sneakers. To sceptics, these deals are outright ludicrous and more evidence of frothy valuations driven by excessive liquidity and speculations. In other words, markets appear ripe for a significant pullback, or worse. It may or may not happen. The truth is no one knows.
Indeed, we might even already be in the midst of a longer-term market downtrend, but which can be confirmed only with hindsight. We do not think so, just like we do not think there will be a recession or contraction in corporate earnings in the near-medium term. Still, the fact is stocks are currently experiencing higher volatility, at the very least. And switching to a more defensive portfolio, buying stocks that are trading at cheaper or more reasonable valuations, will allow one to stay invested — because it is too costly to stay on the sidelines — but reduce the overall risks. Make no mistake, though; this strategy is unlikely to give you higher returns but it would lower the losses, should the worst come to pass.
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The Global Portfolio recovered some lost ground, gaining 4.6% for the week ended Dec 8. Airbnb (+14.4%), Mastercard (+11.8%) and ServiceNow (+11%) were the top performers, after being hit hard during the selloff. Meanwhile, Alibaba Group Holding (-4.1%) and Adobe (-0.7%) were the only two losers in our portfolio. Last week’s gains lifted total returns since inception to 66.9%. This portfolio is outperforming the benchmark MSCI World Net Return Index, which is up 62.7% over the same period.
This will be the last Tong’s Portfolio column for 2021. We are taking a short hiatus and will be back in the Jan 10, 2022, issue of The Edge. For avid followers, we have selected 128 of the most interesting articles published over the last seven years and compiled them in a book. We believe their subject matters remain relevant for investors today and we hope you will enjoy reading them again. The book, Tong’s Portfolio, is now on sale for RM100 at books.theedgemarkets.com, Shopee, Kinokuniya and Lit Books. As a small token of our appreciation, a gift copy will be delivered to all subscribers* of The Edge Malaysia and AbsolutelyStocks in the coming days. Last, but not least, we wish everyone a very Blessed Christmas and Happy New Year.
*With active subscription as at Jan 1, 2022. The Edge Malaysia subscribers apply only to direct subscriptions from The Edge Communications Sdn Bhd.
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
Photo: Bloomberg
