C.J. Lawrence Market Commentary – This Is Not March 2000, Valuations are Much More Reasonable
This post was originally written on May 27, 2022, 5:40 PM EST.
Markets are up 6.2% for the week, a welcome relief going into the Memorial Day weekend! Some of the more hard-hit sectors like consumer discretionary stocks were up 9%. Economically sensitive sectors like financials, industrials, and semiconductors all outperformed the broader market. Longer maturity Treasury yields also peaked and corporate bond prices formed a nice bottom. What is this telling us? Inflation pressures may be easing given the data we got today on the PCE index, the Federal Reserve’s preferred inflation gauge, which is still high at 4.9% y/y, but down from 5.2% the previous month. This is good news and may take the pressure off the Federal Reserve.
The selloff especially in technology and financial stocks has created interesting levels/entry points for investors who have a longer investment horizon. I am hearing from my friends at institutional trading desks, that there is significant buying interest both in the public and private markets given the mountain of cash that is available among institutional investors. As we have reported previously, multiples (valuations) have come down quite significantly in certain sectors which are catching the attention of institutional investors. Who knows if this week constitutes a bottom, but our fundamental work on our portfolio companies post the current earnings cycle suggests fundamentals are still quite attractive.
A case in point is Nvidia, which reported impressive growth in its semiconductor ecosystem, including datacenters up 83% y/y, gaming up 31% y/y, and auto-related chips up 10% y/y. Margins expanded 0.90% versus a year ago and 0.10% sequentially, which is another data point suggesting that elevated margins in the current cycle may not be unreasonable. Nvidia’s stock is up 16% off its recent low earlier this month. Ulta Beauty’s earnings also blew by expectations showing again how resilient its omnichannel platform is. Ulta’s stock is up 23% for the week.
When the broader market as measured by the S&P500 briefly flirted with down-20% last Friday, every noteworthy strategist trotted out a bear market playbook. The average bear market since the Great Depression lasted about 19 months and had an average selloff of 36%. Many point to the period after March 2000, the peak of the dot.com bubble, as a similar period. That one was 3 years of pain; I remember it well! Looking back at markets during different periods in history, it is important to understand the macroeconomic and geopolitical context. Bear markets that were associated with inflation tend to be longer (3 bear markets from 1968 to 1980 for example) and those associated with geopolitical events like the Cuban missile crisis (6 months) or the wars in Vietnam (8 months) and first Iraq (3 months), tend to be shorter. Markets are better at pricing in geopolitical events but have a tougher time with inflation, or the inverse, deflation. What makes the current environment tricky is we have many macroeconomic cross currents, and inflationary pressures combined with geopolitical tensions.
I took a closer look at the period after the peak in March 2000, the peak of the Tech bubble given how much attention it is getting in the media: March 2000 marked the end of one of the longest bull markets which were associated with the buildout of the internet as we know it today. This was the period when we first heard the term “irrational exuberance” in the 1996 speech by Fed Chair, Alan Greenspan. I pulled our valuation sheet from that period from one of our dusty CJL binders to see if we could glean any similarities to today from a fundamental stock picking point of view. These valuation sheets were one of the disciplines our Chairman, Jim Moltz had developed and used constantly to rank our buy universe of about 150 stocks by total return over a three-year period. Here are some highlights:
The S&P500 is much cheaper today on a p/e basis at 18x versus 23x at the beginning of 2000. Looking at our valuation sheets from 12-31-2000 shows a similar picture: stocks today are nowhere near as expensive as they were at the peak of the dot.com bubble. When I pulled 50 of the major companies which exist today from our 12-31-2000-valuation sheet, they traded on average at a multiple 37% higher than today. You may be surprised that we own 13 of these stocks in our portfolio today. One of these is Qualcomm, which we did not own then at 64x expected earnings, but today at 11x it is very reasonable. Of course, the business models of many of our companies like Qualcomm have changed, explaining the shift in relative multiples, but it would be a stretch to suggest that when fishing in our part of the market, larger-cap growth stocks, is somehow associated dot.com-era valuations. The same goes for Cisco, which traded at 48x then, and today at 13x. Pfizer was at 35x, today at 8x. Home Depot at 32x, today at 18x, Schlumberger at 41x, today at 25x. You get the picture! Going down memory lane, AOL traded at 58x, Time Warner at 65x, Palm at 100x, Yahoo at 52x, Sun Microsystems at 39x, Siebel Systems at 104x, Lucent at 44x, Hughes Electronics at 54x, and GE was still relevant at 33x. Most of these companies are either gone or have been absorbed by others at much lower valuations. Apple, believe it or not, was not yet in our buy-universe at that time.
In summary, from this stock picker’s point of view, the relative valuations of stocks were much more extreme in March of 2000 versus today. We have also gone through 20 years of digital transformation since the dot.com bubble which has changed the business models of many companies, especially in the software sector. These companies are today much more predictable given they have shifted to cloud-based, subscription-based recurring revenue models. Maybe that is why Microsoft today is one of the few stocks that sell at a higher multiple as compared to 2000 given its more sustainable business model.