The bargain store is open, can you afford the price? Apologies to Dolly P

The optimism that greeted the new administration a few months ago, known as the Trump bump, has faded into a damp squib as investors digest its new policies. Yesterday, the S&P 500 fell into correction territory—a 10% fall from a recent peak. The Nasdaq’s fall from grace has been even more significant. Some widely held and loved technology stocks like Palantir and Nvidia have seen far greater falls. The Vix index was beginning to show extremes of fear as it rose close to 30 in yesterday’s trading as investors sought to protect themselves against further falls. 30 on the Vix with a few exceptions, the financial crisis being one and Covid being another, tends to indicate at least a form of capitulation, often leading to a technical bounce in stock prices in the short term if nothing else.

Whether policy uncertainty has led to some weakness in the economic data or whether it was heading that way irrespective, as the consumer runs out of cash is a moot point. Still, recent economic indicators have been flagging amber. One recent example is the latest NFIB Small Business Optimism Index released yesterday, which posted a decline for the second month in a row, falling by 2.1 points to 100.7. Business uncertainty soared to the second-highest level in the NFIB survey’s 50-year history. We are all very aware of the decline in consumer optimism over the past few months.

As I mentioned, when the Vix reaches 30, this tends to provide some base, and market corrections of 10%  can often be viewed as healthy.  It provides a valuation reset, and those investors who start to feel the pain exit the market, those waiting on the sidelines decide to dip their toes. It’s only reasonable to look and see if a few bargains have appeared on the scene. Is your favourite store suddenly having a mid-season sale?

The trouble is, despite this correction, US stocks are still not cheap relative to history; it almost appears as if investors have become immune to trading the market on higher expectations, which was often fine during zero interest rates but seems more challenging to justify when interest rates are where they are today.

I highlighted Walmart recently after it posted its earnings; it is undoubtedly a great company, but it provides a good example of what I refer to for illustrative purposes. Its 10-year average for Walmart P/E is near 20x, and this is during zero interest rates. After a 15% correction in the past month, the company, according to consensus earnings, has a price-to-earnings ratio that remains well over 30x next year’s forecasts. For the sake of an argument, one downgraded earnings by 10%, and the company reverted to its 10-year average P/E; one is talking about a potential additional 50% fall in the share price. Walmart is just one example; there are others.

Remember, these are just my views, purely illustrative, before everyone hits the panic button on Walmart. Quality companies also often deserve a premium to the market. There may also be very good reasons why Walmart now justifies these multiples. My point is more that this correction may have thrown out some opportunities. Yes, a bounce is probable, but bargains—there will be some, but not yet obvious and may not be easy to find just yet.