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The markets have been very volatile and very poor for nearly six months now.  A good deal of that volatility has not been seen in the benchmark index numbers because several of the largest firms, Apple, Alphabet, Microsoft, Nvidia, and Amazon had actually held up ok.  However in the last month or so even these have pulled back. Some of the businesses we own are down over 50% from their all time highs which were reached less than 6 months ago.  The speed of the decline has been brutal.  Some of the hard hit names have included Sea Limited, Spotify, Roku, and Etsy.

Why have these businesses declined in market value?

Buy, Hold, and Verify

One of the things I always want to make sure we are doing is verifying our thesis to ensure that it hasn’t changed when stock prices decline. Instead of Buy and Hold, I prefer to Buy, Hold, and Verify.  And we have been doing a lot of verifying over the past 6 months.  After all we will make mistakes from time to time, and holding on to our mistakes is as big a mistake as buying it in the first place. One of the conclusions we have drawn from this verifying is that the businesses we have invested in are as sound as ever.  At worst we can say our timing was not great with some of our investments as I would have preferred to pay the current prices for these businesses.  But in verifying the businesses and the thesis behind our investments, I can’t find any real changes to the strength of the underlying businesses.  As such I am strongly of the belief that the share prices will return to their previous high levels in time.  How soon that will happen, I can’t really say.  It could be as early as the second half of this year, and it might take a year or two.  But time is the friend of a great business, and we own some really great businesses.

Why Have Businesses Declined in Market Value?

If these businesses are so great, why have their share prices declined as much as they have?  I think there are a few factors at play:

  1. The higher inflation rates have caused speculation that central banks will have to raise rates a lot faster then anyone had previously had anticipated. Interest rates are like gravity on stock prices.  The higher the rates, the stronger the pull downwards on stock prices.  This can be especially true on higher growth companies because a lot of their value is in future value, and interest rates affect assets in the future a lot more than assets today.  (It is important to note though that the change in interest  rates does not affect my valuations on the companies that we own.  The reason is because I don’t use interest rates as a discount rate for valuation like the majority of the finance industry.  Instead I use a 10% hurdle rate as a discount rate.  The theory behind this is that if we are going to put our capital at risk in equities, I want to achieve at least a 10% return at a minimum.  So I assume a 10% return and then work backwards to see what price I would be willing to pay for a business.  I then build in a large margin of safety to ensure that even if my assumptions about the future are wrong, we can still make our 10% return.  The only time interest rates would impact our valuations is if rates rose above 10%. But we are a long way from that happening.)
  2. Another factor which is compounding the declines is the prevalence of quantitative, momentum, and index funds nowadays.  These funds all tend to pile into trades at the same time, so they can really dramatically drive the prices to extremes.  This is actually a very positive thing for us, as we can take advantage of their robotic trading and the price volatility.  But it can certainly amplify the declines in the short term and if you don’t understand what is happening, that can be scary.
  3. We are exiting the pandemic finally and since a lot of these companies benefited from COVID the narrative around their business has had to change.  While I think there will be some companies who will be “one hit wonders” during the pandemic, I think all of our businesses were strong companies even before the pandemic and they have emerged even stronger on the other side of it.  E-commerce, platform businesses, AI, and Cloud, were all secular trends before the pandemic and that trend isn’t going anywhere.

What Can We Do About These Price Drops?  

Well the best thing you can probably do is invest more money at this time.  This is the best time to invest in at least the past two years.  No one can predict the movements of the market in the short term and it’s very possible we could be in for some more drops in the next few months.  Still I am confident that any money invested today will generate very stellar returns over the next five years.  If you have money to invest, now is a good time to put that money to work.

- Craig White, BA, LL.B., CIM®

Craig White is a Portfolio Manager and Investment Advisor at Endeavour Wealth Management with iA Private Wealth, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Craig White a Portfolio Manager and Investment Advisor for iA Private Wealth and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.

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