In bull markets, investors take bad news in stride and a yawn. In bear markets, investors become hypersensitive to bad news. They react swiftly and decisively, thaki9ng share prices down, sometimes sharply.
A case in point is, is Epam Systems. In the company’s words, “EPAM Systems, Inc. provides software product development and digital platform engineering services. Its service offerings cover the full software product development lifecycle from digital strategy and customer experience design to enterprise application platforms implementation and program management services and from complex software development services to maintenance, support, custom application development, application testing, and infrastructure management. Its service offerings include Software Product Development Services, Custom Application Development Services, Application Testing Services, Enterprise Application Platforms, Application Maintenance, Support, and Infrastructure Management Services. It offers solutions and services to industries, such as financial services, media and entertainment, travel and consumer, software and hi-tech, and life sciences and healthcare. The company also provides cybersecurity services.”
From an economic standpoint, the company sits in the sweet spot of the technology world. Their products help companies develop, host, deliver, and protect software and applications assisting companies in fulfilling their digital and online business objectives.
Unlike many companies in the software and enterprise development business, Epam is very profitable and growing earnings at a rapid pace. For the past seven quarters, the company exceeded analysts’ expectations, which helped propel the stock to new heights.
But something happened on the way to paradise. By the end of 2021, the share price peaked at about $750. Then the share price began to show weakness. The stock was trading down at the $450 level by late February. For many, this seemed like a place where one might want to “buy the dip.”
At that point, there was a tug of war between the bulls and bears, as evidenced by the sideways trading action that took place for about a month. Then the bottom fell out. So what happened? The company announced that they would pull earning guidance for 2022 as they have a development and support staff in Ukraine and would move those folks to a safer place. Naturally, this will disrupt its ability to fulfill its mission and service its customer.
On February 28, the share price fell from $386 to a low of $197 in a matter of hours. The stock has recovered with a micro bounce to $211 a share. It seems someone knew that trouble was coming to Ukraine, and these folks sold the stock in Q4 of last year. From its peak, the share price is down 72%.
This situation represents a good case study on growth stocks and bear markets. Fear is a strong emotion that causes people to sell swiftly for financial self-preservation. War certainly heightened those fears as nothing is predictable in a war.
The second point we would like to make is that many tech firms high outside programmers in Russia and Ukraine to write code. So expect more stories like this in the future. We suggested going through your portfolio and reading all these companies’ annual reports. Look to see the extent to which the company employs people in Ukraine, Russia, and other eastern block countries. You might want to hedge these positions or sell them outright.
The third point we would like to make is that growth stocks are valued based on the promise of future cash flows. As these companies grow, their share price increases even as they lose money in the short term. Dips are met with new buying, and the stock keeps on truckin. But growths stocks typically do not have much in the way of assets, particularly those in the software space. Their tangible assets go up and down the elevator every day. As a result, once the promise of future cash flows disappears, the company’s value vanishes, and the share price craters. This situation becomes a common occurrence in bear markets.
As a final thought, the downside of globalization is that companies, big and small, source material and labor from all over the world. As governments begin to flex their muscle, we are sure to see the movement of people and goods become more difficult going forward. This situation is a risk that has not been an issue in the past. It is sure to be an issue in the future.
We want to comment on oil. The global oil price has been rising since the Covid low in March of 2020. Many experts kept saying that the rally would be short-lived. We at TOE were bullish on oil until it hit the $85 to 90 level. At that point, we had conflicting views of oil.
On the one hand, we argued that inflation is here to stay. The price of oil usually rises during periods of inflation. Further, the government has put the kibosh on new drilling and infrastructure on public lands. At the same time, we think the risk in inflation will force interest rates up, driving down the price of equities and real estate. This would likely cause the economy to go into recession, thus lowering the oil demand. So we have become more neutral on the price of oil.
Market prices typically overshoot “fair value” on both the upside and downside. In the case of commodities, the big move usually comes at the end of the cycle as fear takes over. The fear of shortages encourages people to hoard, making the shortage or perceived shortage more pronounced.
Russia products about 10% of the oil consumed every day. Oil companies are shunning Russian oil even as they sell it at a discount to the price of other producers. Furthermore, shippers are reluctant to transport Russian oil. We have seen stories, which we cannot corroborate, that state shippers are asking for up to 5 times the regular price to ship Russian oil.
Oil in storage and the transportation system will fill the gap in the near term. If the war does not end soon, we would expect to see shortages occur, causing economic disruption. The world doesn’t need another supply chain problem, but we think oil is about complicating the future process.
Expect surprises and news flashed to have a negative tilt. Economic activity is getting more difficult, and people’s budgets are squeezed. This news flow is likely to weigh on the stock prices of most companies in most industries.
