When investors are optimistic they tend to be overly optimistic. When they’re pessimistic they’re overly pessimistic. This becomes even more extreme when a herd mentality takes hold.
Investors see others buying equities and feel that they must buy too so that they don’t miss out. Conversely, they see people dumping equities and decide they must do the same, so they’re not the ones left holding it. But this year I think we’re going to see volatility return to levels we saw prior to the pandemic – and that should come as welcome news for long-term investors.
A volatile start to the pandemic
We saw extreme volatility playing out at the start of the COVID-19 pandemic. The single largest drop in Dow Jones history came on 16 March 2020, when it fell 2,997 points or 12.93%. The second largest fall was 12 March 2020, when it shed 2,352 points or 9.99%.
But both losses were more or less immediately reversed. The two largest ever daily gains happened on 13 March 2020 and 24 March 2020, when the market rose 1,985 points (+9.36% ) and 2,112 points (+11.37%) respectively. Those who dumped their stock lost money; those who didn’t stayed relatively even. And those prepared to buy when prices while prices were low won big.
The Long Boom
Since then, equity markets around the world have been experiencing a prolonged boom. During the second half of last year, the ASX200 reached its all-time high of 7,632. A little later, on 5 January 2022, the Dow Jones reached its highest peak of 36,952.
One of the main reasons for this is that low inflation and low interest rates have made cash an unappealing place to keep capital. Another reason, partly related to this, is the sheer number of retail investors – especially mum and dad investors – who have entered the market for the very first time.
Data shows that retail investors’ share of transactions on the ASX almost doubled between 2019 and early 2021. Trading equities – just like trading cryptos – has become a popular past-time. And why wouldn’t it? Making money on equities has not been difficult over the past couple of years.
Between the market bottom of 20 March 2020 and 31 December 2021, the S&P 500, the index that tracks the 500 largest listed equities in the United States, rose from 2,304 to 4,766 – an increase of almost 107%. In other words, a passive investor who did nothing more than put money into an ETF tracking this index could have expected to more than double their investment. And yet, this impressive return was nothing compared to the rise of many tech stocks.
Tech-boom 2.0
As soon as COVID-19 hit, many of us noticed that the pace of technological change was accelerating. With our lives moving online – including our workplaces – digital infrastructure, software, online retail, social media and other tech-based companies became main targets – especially for new investors. Those companies that we’d suddenly started to notice had their share prices take off.
Between 20 March 2020 and 16 October 2020, shares in video-conferencing software provider Zoom Video Communications Inc (NASDAQ: ZM) went from $130.55 to $559.00 – an increase of 428%. Shares in cycling simulator manufacturer, Peloton (NASDAQ: PTON), went from $23.01 on 20 March 2020 to $162.72 on 24 December 2021 – a rise of 726%.
Stock in both companies took off, not because they were profitable, or even had a clear path to profitability. They became popular because people noticed that their products were being used and felt that they must be valuable. Investors simply cast earnings aside altogether as a measure of a company’s value. At its peak, ZM was trading at a price-to-earnings ratio of more than 3,464.
Many of us that have been around for a while remember the dot.com boom of the late 1990s and can’t help but draw parallels when paper millionaires were created and disappeared overnight. Although it pays to remember this time around giants such as Alphabet Inc (Google), Meta Platforms Inc (Facebook) and Apple, have all risen sharply, although quite not as spectacularly, since the pandemic began.
Harder Road Ahead
Looking forward, it’s unlikely that 2022 will be anything like the past couple of years. It’s more likely that the early pandemic volatility will return.
The optimism we’ve seen for tech stocks over the past couple of years is dissipating, with the price of major players sliding, if not plummeting. The ASX and Dow Jones are both now 8% to 15% lower than their market peaks. The tech-focused NASDAQ is now 19% below its high.
One factor that’s not often mentioned with these corrections is that they are almost certainly more severe than they should have been. The number of first-time investors in the market, the highs of the last couple of years were higher. Now the pullback is stronger too. What’s more, there are real risks on the horizon from the war in Ukraine to an oil price shock, to a new coronavirus variant, to the spectre of stagflation.
While the risk events like these pose are generally factored in by the market, I expect they will be met with even more dramatic action than we’re accustomed to. That includes, of course, the possibility that capital will disappear from the market as many retail investors take their money out and put it into something less prone to losing value.
Sectors to Watch
That said, there are two sectors – renewables and medical technology (MedTech) – where I believe the market still has a way to go. But rather than jumping on the bandwagon of whatever stock is hot, it will pay to base decisions on concrete data. For instance, the Biden presidency’s recent announcement that it was committing US$8 Billion to hydrogen based clean energy hubs should be good news for Australia’s hydrogen sector.
The other thing to remember is that volatility can be a positive thing for investors looking to the longer term – providing the opportunity to acquire quality equities while prices are low. Those investors looking for genuine value instead of riding market sentiment are likely to find this a good buying year.
