Mega cap tech stocks like AAPL, MSFT, META, AMZN, GOOG, and NVDA have had an enormous run in the past two months. Their valuations are no longer cheap and I'd say some of them are at fair value, while others are stretched too far. I'd put GOOG, META, (maybe AMZN) in the fair value category and AAPL MSFT and NVDA in overvalued category. However, in the short to medium term, valuation doesn't usually mean much to money managers and it's the quantitative-based traders who trade based on technicals and momentum who run the market and determine price action. The AI hype has boosted some of these mega cap tech stocks , especially GOOG, MSFT, and NVDA. I think it's a good time to hedge against megacap tech stocks. There is still uncertainty in the economy but these megacap tech stocks are not pricing in a recession, so the downside could be significant IF the economy takes a turn for the worse.
As for where I see the most enticing long-term opportunity right now, it is probably in small-to-mid cap tech and growth stocks. These were hammered the most over the past year and a half, and are still down significantly, trading near all-time low multiples. Some examples of these industries are cybersecurity, enterprise software, fintech, etc. While these small/mid cap growth stocks have seen significant rallies over the last couple months as well, the recovery is not over in my opinion and will extend into the coming months and years. Many of them remain short-squeeze candidates as well. There are several of these smaller companies that are in the AI realm and are continuing to see positive momentum. Many of these small/mid cap growth stocks are secular growth stories that are not as impacted by the macro-economic environment, while mature tech companies like mega cap tech stocks are more susceptible to macroeconomic environments.
A prudent strategy for young investors looking for some risk would be to allocate a portion of your portfolio into 10-20 of these small/mid-cap growth names. The likely outcome, if you pick quality ones, is that perhaps a quarter of them will give massive returns in the long-term to make up for any of the other ones that fail or underperform. These smaller companies have a lot more growth ahead of them than mature megacap companies, but have more risk. That is why I think the best way to manage risk for these unpredictable, speculative smaller companies is to diversify into your favorite 10-20 ideas, where you are likely to have a couple of huge winners. In the end, the losers can only fall 100% but the winners can go up an infinite amount.
I think a long-short strategy is prudent right now to protect against broad-based economic meltdown. I am long several small/mid cap growth stocks and a few reasonable-valued large cap stocks. I am short large cap tech stocks trading at or near all time high valuations, cyclicals such as industrials and some oil, and consumer staples trading at high valuations. I am also short the broad indices (SPY/DIA). The key factors I look for right now in a stock are 1) positive cash flow, 2) reasonable/cheap valuation on a historical basis, and 3) resiliency in the case of an economic downturn. If the economy takes a dump, I think my shorts are more susceptible to macroeconomic conditions and will thus cover my ass if my longs decline as well. If the economy continues to be resilient, my longs will continue their secular growth stories and once again garner premium valuation multiples, hopefully performing better than my shorts.
While I significantly underperformed the market in 2022, I have been significantly outperforming the market in 2023 so far with my strategy above. My portfolio year-to-date is up 60%, compared with 14% for the S&P 500, 0% for the Dow Jones Industrial Average, and 30% for the tech-heavy Nasdaq. This outperformance is clearly due to the outperformance of tech and growth stocks, which I was fortunate enough to have accumulated throughout 2022. There is no guarantee this strategy will continue to work, but my bets are on the outperformance of tech/growth over cyclicals/value/consumer staples. The beginning of 2023 is a reminder to use weakness as an opportunity. While there will probably be a short-term correction in tech stocks given how much they've run up, investors can use this as an opportunity.
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