Last week, I made you a promise.
I said we’d discuss one of the biggest potential threats to payment disruptors, FedNow.
The essay is done and dusted, but it’ll have to wait another week.
Instead, we must talk about the topic on everyone’s mind… what’s going on with stocks?
Today, I’ll show you what’s behind the stock market volatility… and how to use it to your advantage.
The market sold off hard over the past few weeks.
The tech-heavy Nasdaq fell into “correction” territory for the first time in almost two years. Over 40% of Nasdaq stocks have been cut in half.
This selloff has many folks panicked. By one measure, investor sentiment is even worse than during the COVID-19 crash in March 2020.
What’s giving investors sleepless nights? The chief concern is rising interest rates.
In short, interest rates are the cost of money. For example, if you have a variable rate loan on your car, your monthly repayments might have inched up recently.
Interest rates don’t only set the price of money. They also influence stock market valuations.
Super investor Warren Buffett called rates “the most important item” for stock prices. In fact, he’s compared them to gravity, saying: “Interest rates are to the value of assets what gravity is to matter.”
When interest rates are low, stock valuations can go to the moon. But rising rates pull prices back down to earth.
This is what we’re seeing today. Tech stock valuations have collapsed by 30% on average. In fact, tech stocks are at their cheapest levels since late 2018.
Here’s my “script” for this selloff.
It’s important to remember big stock market drawdowns like this typically follow a predictable pattern. Right now, we’re in phase one of the selloff… where folks panic and sell everything without thinking.
It doesn’t matter if a company just posted its best quarterly results ever. Or if it crushed Wall Street’s expectations. In this phase, folks panic now and think later. Investors will sell stocks even if there’s no good reason to.
This indiscriminate selling phase usually doesn’t last long. The last big selloff we saw—the March 2020 COVID crash—lasted roughly a month and took the S&P 500 down about 30%.
In late 2018, this phase ran for around three weeks, during which the market fell 19%.
Now we’re approaching phase two of the selloff.
I love this period, and you should too. It’s when the market separates the men from the boys. In phase two, the strongest stocks carve out bottoms. These emerging leaders start rising again when most stocks are still stuck in the mud.
The market has followed this script many times before. Take the COVID crash, for example.
First, the whole market collapsed. But then new leaders emerged, like online shopping pioneer Amazon. Amazon bottomed weeks before the S&P 500 found its footing. By the time the S&P broke back above its pre-COVID high, Amazon had already surged 61%.
There’s a special type of stock you want to buy right now.
This selloff rocked the whole market. But it’s been particularly brutal for unprofitable tech stocks.
I doubt this trend will change anytime soon. Companies with poor businesses, or those with no hope of turning a profit for years, will continue to get pummeled.
But that doesn’t mean you should avoid tech stocks. Fast-growing companies that print cash will do phenomenally well. In other words, you want to own companies with strong sales growth and lots of profits. Or at least a solid roadmap to profitability.
Consider how one of my favorite businesses—data disruptor Snowflake (SNOW)—stacks up against overhyped exercise bike company Peloton (PTON).
At first glance, they’re both lofty-valued tech stocks that have been hit hard. But the market is telling us they’re nothing alike.
Twelve months ago, Snowflake traded for 160X sales. Today it trades for under 80X sales. In other words, its valuation has been cut in half.
You’d expect Snowflake’s stock to have collapsed too, right? Yet… it eked out a 2% gain. What gives? Snowflake’s business is growing so fast it more than made up for its valuation getting cut in half.
Peloton is the opposite. Its valuation plunged by 90% over the past twelve months. And unlike Snowflake, its stock collapsed right along with it—by 80%.
This has been a nasty dip in the markets… but it’s also an incredible opportunity.
It’s been a rough few weeks for investors. I feel it looking at my brokerage account.
But big picture, this selloff is handing us the opportunity to buy great disruptive stocks at huge discounts. World-class businesses that reported record earnings are selling for 25% of where they were trading a few months ago.
Investing is a strange game. When you see a nice jacket selling for 25% off, you’re tempted to buy it, right? But when it comes to buying stocks, logic goes out the window. Discounts and lower prices repel investors.
If you take one thing away from this essay, let it be this. Don’t let falling prices scare you away from great stocks. Instead, we’re stalking the market for great buying opportunities.
Stephen McBride
Editor — Disruption Investor