Conventional wisdom misses the mark (as usual)

image: Wikimedia commons (link).

The markets are presently selling off sharply, with smaller companies and tech-related companies being sold even more vigorously than the overall market.

The chatter that we are hearing involves three widespread (but, in our opinion, misguided) pieces of "conventional wisdom" on the Street: 

  • First, that inflation makes smaller companies whose earnings are more "in the future" than "already in hand" significantly less attractive and less valuable,
  • Second, that inflation concerns will cause the Fed to raise rates more aggressively which will also negatively impact smaller and more future-oriented companies,
  • And Third, that the Omicron variant appears to be much more contagious but much less severe than previous variants, and that if this variant sweeps across the country without causing too much damage, it could create widespread "natural immunity" and thus bring an end to the attractiveness of "Covid-related" stocks, including many technology stocks and the stocks of companies which benefit from the "work from home" and "stay at home" theme.
A look at the performance of various stocks and of various indices over the past several days shows plenty of evidence that the above three pieces of misguided conventional wisdom are behind much of the market action. The Russell 2000 index (a small-cap stock index) has broken blow its 200-day moving average as this post is being published, and other examples could also be offered.

But while there is no denying the spread of either inflation or of a highly-contagious variant in recent weeks, we would argue that the above interpretations miss the mark completely regarding what all this means for smaller, more innovative, and more technology-oriented companies. 

First, we of course agree that inflation is an extremely negative development, and one that doesn't help most businesses and certainly doesn't help the general standard of living. However, we completely disagree with the conventional wisdom that argues that in an inflationary environment, it is better to invest in the stocks of "cyclical" and "defensive" companies, and to sell the shares of smaller companies (and especially smaller companies whose growth and earnings is more skewed towards the future).

We understand where this thinking comes from -- but we simply disagree with it. 

Based on our experience as professional portfolio managers for going on four decades, in an inflationary environment, we would much rather own the shares of innovative and well-run businesses which are positioned in front of the narratives that are most likely to succeed over the next five to ten years, versus  just about any other asset anyone else can suggest (including cash)!

And, as for the convoluted "Omicron" argument which some of the "hot money" on Wall Street are using to guide their so-called "investment decisions" (more accurately, their computer-trading algorithms), we would of course welcome anything that helps bring an end to the lockdown mania that has taken control of the thinking of so many technocrats around the world (and here in the United States). 

But while we can't stop algorithmic traders from selling stocks based on their attempts to predict the end of the "Covid story," we think it is a particularly egregious example of the kind of non-fundamental speculation that drives so much of the market action today -- speculation that is extremely unproductive and which real investors should shun.

As we have explained many times in this blog over the years (now going strong since 2007: fifteen years!), our strategy is based on owning well-run businesses in front of future fields for future growth

It just so happens that the narratives we identified regarding the future were, in almost every case, accelerated by the events of the past two years, but that only goes to show that those narratives we identified were correct descriptions about the way that technology would play a bigger role in more areas of our life in the future (the lockdowns only made that happen faster than it would have otherwise).

We find it to be ridiculous to think that, just because the damaging and (we would argue) nonsensical lockdowns might finally be coming to an end, investors should get rid of any stocks that are involved in the very narratives which are most likely going to continue for many years to come. 

As an important aside, we do also recognize that the valuations of some of the companies we own did indeed get carried higher than they should have during the Covid-story-based buying during 2020 and early 2021. Now many of those valuations are being taken down severely. But this kind of over-reaction (in both directions) just underscores the necessity of our standard practice of owning good companies through the various market cycles, for as long as they remain well-managed businesses in front of fertile fields for growth.

And so, during the current market correction, we would advise real investors to avoid getting caught up in mistaken conventional talking points which miss the mark when it comes to the kinds of companies that are best to own for the future.  We would be using this "growth correction" to deploy idle cash.

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