You need to open these doors with care and caution, but first you need to know how to close them. And above all, you have to know which doors should not be opened…” ― Michael Bentine, Gates of the Spirit
April ended happily on Friday for investors. It was a memorable month for all the wrong reasons and ended in a rout on Friday as the NASDAQ fell 4% for the day. Amazon (AMZN) sold nearly 16% on quarterly earnings and guidance, the online retail giant’s biggest daily decline since 2006. The NASDAQ fell more than 13% in the month and is now down around 22% for 2022. To put it in perspective, this is a bigger monthly drop than what accompanied the moronic lockdowns of March 2020. You have to go back to the financial crisis to find a more dismal performance for the heavy tech index, as it fell about 17% in November 2008.
It was a volatile month as all FAANG stocks, with the exception of newly Meta platforms (Facebook), published disappointing results and/or forecasts in the first quarter. Another exception to the decline in technology this month was Twitter (TWTR), which is about to be bought by Elon Musk for just under $45 billion.
Things weren’t much better for the S&P 500 as the index fell 3.6% on Friday to end the month down 10%. It was the only fourth month since 1973 that the S&P 500 was down more than 5% and US Treasuries fell more than 2%. Gold lost 2% on the month to settle just above $1,911 an ounce, its worst monthly performance since last September. In short, there were few hiding places for investors in April.
One of the main reasons stocks have fallen is that the economy is deteriorating, both domestically and internationally. The IMF recently revised down its global growth projection to 3.6% for 2022 and 2023 this week. This marks a sharp decline from last year’s level of 6.1% and the 4.4% growth the institution had predicted for 2022 in early January. Wednesday saw negative GDP in the first quarter to print. Although, given some of the adjustments contained in the report, the economy is not as bad as the negative 1.4% level posted and is likely to be revised somewhat in future updates. The Atlanta Fed’s GDPNow currently projects GDP growth of 1.9% in the second quarter.
New COVID lockdowns in China cannot be good for the global supply chain, which has already been congested for several quarters. Shanghai alone handles 20% of China’s export traffic and has been in severe lockdown mode for weeks now.
The 10-year Treasury yield is rapidly approaching the 3% level, and the Federal Reserve is expected to raise rates another 50 basis points in May. This spike has had a huge impact on mortgage rates, with the average 30-year mortgage lending just north of 5% currently.
With the median selling price of a home up 16.7% over the past year, the ‘medium‘home now comes with a monthly payment 35% higher than it was 12 months ago. This does not bode well for the housing market which is a key economic driver.
So with a dismal April in the bag, what can investors expect in May?? Here are three things I think will happen in the coming month (feel free to post your own predictions in the comments section).
Biotech will be downstairs:
It’s been a miserable 9-12 months for biotech investors, as seen above. Rising interest rates have pushed ‘high beta‘ sectors like biotechnology down at all levels. The continued impacts of the pandemic have hampered sales traction for many small and mid cap names. Additionally, the FDA appears to have been overwhelmed with its COVID-related work. Their decision-making process on many small and medium-sized business marketing applications has been anything but consistent, even though everything related to COVID-related vaccines and treatments seems to be rubber-stamped by Big Pharma.
Second, there has been a dearth of M&A activity in the sector despite huge price declines from a myriad of interesting small- and mid-cap companies. small plug Zymeworks(SYME) got a offer Last week. One would think M&A activity would pick up in the coming quarters given the number of bargains in the space and how cash-rich Big Pharma has become. To put it into perspective, there’s a week before last week’s rout; there were about 250 small biotech names trading below the net cash on their balance sheets. In addition, some 600 biotech companies have fallen by 50% or more in the past 12 months, with nearly 350 of these falling by more than 70%. Given this, it’s hard to see how sentiment can turn more negative on the sector.
Ukraine will continue to be full of potential landmines:
The war in Ukraine has just entered its third month. The cost in lives and destruction has been enormous on both sides.
Despite this, neither side seems genuinely interested in seeking peace at this point. The current administration seems determined to fight this war to the last Ukrainian in ‘weaken‘ Russia as Secretary of Defense recently declared. So far they have asked for some $50 billion in aid from Ukraine as well as indefinite aid’lend-lease‘ program, primarily for military efforts. To put that into perspective, Ukraine’s annual budget for its military before the invasion was $6 billion.
Please note that none of these comments excuse Putin’s absolute barbarism which is inadmissible. However, from a realpolitik view, we are moving through very dangerous waters. It is hard to see how Europe will avoid a recession at this stage, especially if energy supplies are interrupted. So far, EU sanctions have had little or no impact on Russia. The country has received 40 billion euros from Europe in the past two months for oil, natural gas and coal thanks to much higher commodity prices. Putting that into perspective, Russia earned 141 billion euros for these exports to Europe in 2020.
Also, we haven’t started to see the major impacts of the war on the global food chain, as this part of the world exports huge amounts of fertilizers, wheat, corn and nutrients. As a result, tens of millions of people in Asia and Africa will face significant food insecurity, while in the West, commodity prices will continue to rise at a breakneck pace.
The risk of an event in Ukraine causing a significant increase in market volatility in May appears high. This could stem from growing fears that Russia may use low-yield chemical or nuclear weapons or from an unintended escalation (eg missile strikes on a weapons convoy just outside Ukraine’s borders). The most likely event is that Europe adopts much tougher energy sanctions against Russia, which increasingly seems likely. This would cause a huge spike in oil prices and almost instantly put Europe into economic contraction, and could possibly do the same in the United States where gas prices are near all-time highs.
The dollar has peaked:
One of the most disconcerting things to me about the market is that the greenback is so strong given the myriad challenges the United States faces on the domestic and foreign policy fronts. The Dollar Index reaches 20 years high this week as the yen fell to its lowest level since 2002 against the dollar while the euro hit its lowest level in five years on growth concerns. Talk about being the best house in a bad neighborhood.
I don’t think this is sustainable for a myriad of reasons, including mean reversion. Also, I think there is at least a 50/50 chance that the country will be in a recession in the next 12 months. I am also thinking of the Fed’flashes‘ by the end of the summer thanks to major disruptions in the economy and markets. Monetary tightening has been a driver of recent dollar strength.
Finally, the sanctions against Russia, including the freezing of hundreds of billions of assets, may have been well intentioned. However, this series of ill-conceived guidelines should have the unintended impact of undermining the dollar as the world’s reserve currency. China was already making inroads on this front before the invasion and asset seizures will only accelerate these efforts. Over time, this could significantly weaken the dollar. The share of the dollar in foreign exchange reserves had already fallen from 71% in 2000 to 59% in the third quarter of 2021.
A weaker dollar will be another tailwind for commodity prices (since most are valued in dollars) as well as continued inflationary pressures.
Given this outlook, I remain cautious on the broader market despite the strong equity sell-off in 2022. My cash allocation remains in the 25-30% range. I act on almost all new opportunities via covered call orders that provide additional downside protection.
There will be a time to buy this dip in a major way at some point in 2022. However, I don’t think we’re close to ‘capitulation‘ at the moment, outside of certain sectors like biotech, and so I remain patient.
Your inability to see someone else’s wisdom isn’t a reflection of their lack of insight, it’s a reflection of yours.. ”― Ilyas Kassam
Bret Jensen is the founder and author of articles for the Biotech Forum, the Busted IPO Forum and the Insiders Forum