Multiple Portfolio Headwinds in 2022

Our outlook for 2022 is one of serious caution. We face headwinds from multiple related fronts of sky high stock valuations, COVID, inflation, and geopolitical risks. Combined, its a volatile mix, with any single one being a good reason to tread carefully.

2021 IPO Darlings and High Valuations Will Be Hit

Issuers and bankers took advantage of high investor interest, or otherwise stay-at-home boredom, raising through a record 1,006 initial public offerings, about $315.6 billion! This is the highest number of offerings in at least 25 years, with the last highest being 848 companies, and $78.6 billion raised, during the beginning of the boom. Many of these companies were in healthcare and technology and their valuations were sky high, built and riding on exuberant investor expectations.

A few stocks that really define this exuberance, and posing a high likelihood of decline in a market route are Chewy (CHWY), and Peloton (PTON),  Chewy (CHWY) has P/E ratio on TTM earnings of 2,041! Sales growth was an awesome 47% in fiscal 2021 (ended January 2021), but likely slowed to 20% in fiscal 2022. The problem is that they have had losses, which have been improving, reaching -$92 million in fiscal 2021, up from -$252 in fiscal 2020, but with sales growth falling, it will leave little room for larger gains in income, not really justifying its high valuation.

Peloton (PTON) does not look much better. With losses in the last 12 months and income not expected in the next 12, Peloton doesn't have a P/E ratio to consider. We might overlook this if they had impressive revenue growth that might overcome their expenses, but I see revenue nearly flat over the last twelve months and I don't see this improving with the tremendous pressure they are getting on customer acquisition costs and increasing lower cost alternatives for customers to consider, from Apple Fitness+ and a slew of less expensive exercise bikes. Peloton is in trouble in our opinion and I am betting that this stock will be heading down, and in an accelerated fashion if the market comes under pressure.

Other stocks that you might want to consider lightening up on as I look at them at short candidates include Datadog (DDOG), Snowflake (SNOW), all of which have no earnings, high valuations, and high expectations. Reality is coming.

Large Tech Still Interesting

Technology companies continue to be interesting as we continue the transformative cycle into greater global adoption towards more streaming, more mobile, more corporate data analytics, and more consumer tech. The problem is that so many tech companies are highly valued, leaving little on the table, but I will continue to search. I still love Apple (APPL), which has a TTM P/E ratio of 32 times that is higher end of what we normally would pursue, but its earnings prospects are excellent over the next five years. It's leadership on producing ever-popular consumer electronics with cutting edge technology (It's 2020 M1 chip launch was epic in so many ways--I'll explore that in another post) is unrivaled at this point and its position in garnering a substantial chunk of the profits will continue.

Interestingly, the S&P 500 Index is dominated by 5 large technology companies, comprising around 25% of the index's value--Apple (AAPL), Facebook (FB), Microsoft (MSFT), Alphabet (GOOG) and Amazon (AMZN). Other than Apple, I don't find any of these particularly interesting. Amazon (AMZN) continues to dominate the cloud infrastructure space as well as online sales, but its growth prospects don't compensate enough for its' lofty P/E ratio of 65 times. If the market takes a dive, Amazon's high P/E would likely fall, and it could be very compelling as an attractive investment opportunity.

High Dividend Stocks Are Intriguing

Large capitalization, low valued, high-dividend paying stocks are increasingly looking compelling, such as AT&T, Verizon, and Exxon. The only risk is rising interest rates, which makes these stocks less compelling relative to risk-free assets such as U.S. Treasuries. If we can find high dividend payers with earnings strength, that would mitigate this risk, assuming interest rates only rise modestly, which is where we are inclined to bet.

Verizon (VZ) has a dividend yield of 4.8% and a P/E ratio of 10 times--a perfect combination of strength for a market where you need to be defensive. If the market takes a dive, low P/E stocks will likely experience less price pressure than high P/E stocks. High dividends yields also, in themselves, resist price pressure as falling prices result in higher yields, which in turn, makes the stock even more attractive. Earnings growth prospects are not impressive for Verizon, but they continue to maintain the leading market share in mobile at around 30%, followed only by AT&T at around 27%, and mobile is not declining in utilization--if anything its increasing.

COVID's Economic Impact

With the onslaught now of the Omicron variant, the impact of COVID on the economy will likely be prolonged into late 2022. I had high hopes for airlines being huge beneficiaries of a return to travel, but that was screwed up over the holidays. That full return to travel probably is delayed until mid-to-late 2022. Everyone wants to travel it seems and the lines were long starting in mid-2021, but many cancelled flights diminishes the prospects for a quick return to profits. I'll stay long both Delta (DAL) and Southwest (LUV) as recovery plays, as both airlines have the strongest balance sheets in the industry and have not held back with investments during this tough period. When the swing back occurs, these two will be at the forefront.

China is the Geopolitical Juggernaut to Fear

In the back of my mind, I worry about China and its impact on financial markets. Its' threats this year over Taiwan, the diplomatic boycotting of the 2022 Winter Olympic Games by the U.S., the U.K., Canada and Australia, and corporate, ie. Intel, and Walmart, boycotting of products sourced from Xinjiang, could trigger a response from China in 2022 that rattles markets severely. The precedence for this was four years ago when the U.S. imposed tariffs, which were followed by China imposing tariffs that sent a cold child and dark realization that many U.S. companies were overexposed in both China customers as well as China product sourcing. Many companies have made moves to decentralize their manufacturing and sourcing away from China, but freeing themselves from the attractive large base of China customers is hard to accomplish.  The China risk is big and real, and we will be keeping our eyes on it.

Happy Returns in 2022!

Happy New Year and may your investments do well in 2022! Every year is different, and I try to stay aware of that fact in understanding markets, economies, and companies and let's hope we all get it right this year.

(Note: Out of the securities mentioned in this post, the author and/or NUKU have long/short positions in Apple (APPL), Verizon (VZ), Delta (DAL), Southwest (LUV) and Peloton (PTON)).

Carson Cole

January 06, 2022