Posted May 12, 2022
By Zach Scheidt
Why Good Stocks Get Dragged Down With the Bad
I know it’s not an easy time to be an investor right now.
Stocks are continuing to fall while inflation slowly eats away at any cash sitting on the sidelines.
To make matters worse, even some of the best stocks you could own aren't immune to the pullback.
So I’d like to help explain why this is happening and balance out all the bad news with somewhat of a silver lining.
Earlier this week, I got the chance to sit down with my colleague J-Rod to discuss the current state of the market.
During our conversation, we talked about why good stocks have been getting dragged down alongside the bad ones.
And to end on a positive note, I shared why I think it’s a signal that the current selling period could end soon.
Click on the video below to listen to our discussion.
Let’s start our discussion by stating the obvious — the stock market has been extremely weak over the past few months.
It makes sense that the more speculative stocks and high-flying tech stocks we’ve warned you about are trading lower.
As we look at the market now, even the good stocks are getting beaten down. And I understand that's frustrating.
But I've got a good explanation of why this is happening so you hopefully don’t get too discouraged.
First, it’s important to realize that inflation continues to be a big problem.
This week, we got another CPI report showing that inflation is still hot and weighing both on individuals and the economy.
To fight inflation, the Federal Reserve is in the early stages of hiking target interest rates.
Rising interest rates naturally push stock prices lower — especially the speculative stocks that aren’t earning any profits today but will in the future.
That’s because when you have higher interest rates, future profits become less valuable.
After all, you could earn more by putting your money into an interest-bearing account that will give you solid returns today.
So that’s why speculative stocks have been trading lower. But why are quality stocks that are profitable getting caught in the chop as well?
To answer that, let me tell you a story from 20 years ago at the very start of my hedge fund days.
It was right after the peak of the dot-com crash. I was proud of the fund I worked at because we didn’t lose money as so many other investors did during the crash.
But one day, my mentor Bill came into my office looking pretty frustrated and told me that we had to sell a bunch of our positions that day.
Then he asked me to put together a list of stocks that we could sell.
I was a little confused because I knew Bill was excited about our positions. We were in a pretty good spot and held onto many solid stocks.
So I asked him why we had to sell. And he told me, “Well, we have redemption letters.”
To an investment manager, this was pretty much the worst thing you could possibly hear.
It’s when your investors tell you that they need to pull cash out of their accounts. And that meant we had to sell some of our positions to free up their money.
Now you may be wondering why they needed to pull their money out. It’s because they lost money in so many other areas of the market.
And they needed money to fund their day-to-day expenses.
So they decided to pull their money out from the fund that still had money because we didn’t lose it during the dot-com crisis.
In other words, they pulled their money out of the one area that was doing the best because that’s where they had the most money.
Investors are doing pretty much the same thing today.
They either need to free up cash to pay their expenses or they're afraid of the recent pullback. So they’re selling the stocks that have held up well since that’s where their profits are.
That’s a big reason why quality stocks are trading lower here at the end of the recent bear market trend.
I understand that it doesn’t make it any easier for you as someone holding onto these stocks. And it can be frustrating to see your investments trading lower.
But I think it’s a sign that we could be nearing the end of this particular selling period.
It also gives you the opportunity to buy more shares of quality stocks at a discount while they’re still trading lower.
So that’s the silver lining as we look at the current state of the stock market.
Here's to living a Rich Retirement!
Editor, Rich Retirement Letter