How the market can play with you (NOTW#39)

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Both indices were (unexpectedly) significantly up this week. This demonstrates that markets are unpredictable and also portrays why the market are so psychologically tough. I go over both things in the market commentary.

Without further ado, let’s get on with it.

Articles of the week

I published one article this week: ‘Why I Am (Still) Adding to Nintendo.’ It’s an in-depth valuation analysis explaining why I still believe Nintendo is attractively valued at current levels. The goal of the exercise was not to be precise (although I tried) but to understand what IRR is embedded into the current stock price while being very conservative in the exercise. To find this out, I had to estimate…

1. Nintendo’s assets

2. The legacy Switch 1 business

3. The nascent Switch 2 business

4. The evolution of the NSO (Nintendo Switch Online) subscription

It took quite a bit of effort to write and I am happy with how it’s being received thus far.

Next week, I will also publish a podcast episode on Nintendo with Ryan O’Connor (founder and CIO of Crossroads Capital). Feel free to follow the show on Spotify, Apple Podcasts, or YouTube. The podcast, as always, will be free, although paid subscribers will also have access to the transcript.

In addition to this, I am working on my next in-depth report, which I plan to release sometime this month.

Without further ado, let’s see what the markets did this week.

Market Overview

One thing makes financial markets interesting/exciting: their unpredictability (at least over the short term). One would’ve thought that, after all the doom and gloom we’ve been reading in financial (and non-financial) media, markets should’ve been significantly down this week…but they weren’t. Both indices were up more than 5% during a week when the US and China raised their tariffs to above 100% rates:

Many people were quick to claim that this is just a dead cat bounce (a rally within a bear market), but it’s worth keeping in mind that these people claimed last weekend that we were in for a very rough week! In short, they pretty much have no clue what will happen next.

Now, with this said, I do believe there are reasons to be worried. The narrative seems to be pivoting from “tariffs” to a “recession” after two events that took place this week:

1. Trump imposed a 90-day pause on retaliatory tariffs on all countries except China (which saw its retaliatory tariff increased again). It was interesting to see the market rally significantly on this news when, as far as I am concerned, China was the pain point from the beginning and remained an even bigger pain point following this announcement. Never forget that most of the daily trading is done by algorithms (I believe it’s somewhere around 60-70% of daily volume)

2. Trump openly stated that the US administration wants to sign a deal with China. I don’t expect this to be a short negotiation, but this definitely seems like much better news than the pause on retaliatory tariffs. Ironically, the markets slumped the day the President said this.

Some people speculate that all of the above happened because the bond market “showed” the administration that they might have made a policy mistake. Rates spiked significantly during the weekend and are now considerably higher than pre-Liberation Day. This, imho, demonstrates that it takes more than one man to be able to crash global trade, as there seem to be some “defensive measures” in place to make people rectify.

While tariffs seem to be starting to be a “non-issue” with a resolution maybe happening here in the next few weeks, there are now recession fears, and I must say these fears make sense. Investment and consumer confidence hate uncertainty and are getting quite a bit of it lately. We’ll probably see commentary from many companies during Q1 earnings calls stating that they’ve slowed down investments and hiring and that consumers might have slowed down spending. The tariff policy's “second-order” effects could eventually translate into recession, but we’ll have to wait and see. Worth noting that forecasters have probably called 10 recessions over the last 5 years, and they’ve not been right once. They will be right sometime, and they seem to have a pretty good shot at being right this time, but odds are not 100%. Even if one manages to forecast a recession, they still need to get two things right: the depth and length (good luck with that!).

The bullwhip effect is something quite relevant here. I think we’ve seen a persistent trend in the markets lately: companies levered to Capex go down/up faster when bad/good news surface. This might have to do with the bullwhip effect, as companies are likely to cut first on Capex under an uncertain scenario but have to continue spending on Opex. This might be why some of the portfolio companies tied to Capex spending (in one way or another) are seeing so much volatility. Semicap equipment companies might be a good example of these dynamics.

I am not going to be the one to tell you if there will be a recession or not, but I can tell you that I am not extremely worried about one, considering what I believe about the resilience of my portfolio through one (many companies would probably come out stronger on the other side). What I do believe is that, if this week demonstrated anything, it was that the fate of the market (at least over the short to medium term) rests on one Truth Social post or one media headline. It’s honestly very tough to know what will happen under this scenario, but this is precisely why some stocks are cheap. Stocks don’t tend to get cheap when visibility is high, but when visibility is low or non-existent.

The current scenario portrays how the market can play with investors, even with the most experienced. Let me explain what this might look like. When stocks are dropping, there seems to be no reason to be positive; recency bias kicks in and makes us think that the most likely move is going lower. Granted, when there’s so much uncertainty, there will be many reasons to be bearish as imagination flies freely. However, when stocks climb for any reason (rational or not), FOMO (Fear of Missing Out) kicks in, even if it’s a dead cat bounce. This ultimately means that all it takes to make investors flip from negative to positive (and therefore from fear to FOMO) is a stock market rally. This goes something along the lines of “price drives sentiment.”

The problem is that there might be little signal in stock market moves, meaning that investors might get wrong-footed several times in a row due to their inherent pro-cyclicality. Being wrong several times in a row ultimately makes investors lose confidence. Imagine you think stocks are going way lower, so you decide to wait to deploy your cash even though great opportunities exist (i.e., you freeze). Stocks indeed go lower for a while, but you try to time the bottom, so you wait.

Suddenly, some good news comes out (typically when nobody expected them) and markets soar. You don’t know if the rally is the one that will take the markets to all-time highs or a dead cat bounce, but you surely don’t want to miss out on it, so you turn bullish and deploy your cash. Then, stocks go lower because it was indeed a dead cat bounce. Now, you feel terrible because you have deployed your cash, and there are even better deals in the market. You flip bearish again. Then there’s another rally, but you’ve lost trust in the rallies because you believe it’s a dead cat bounce (as it has been for the last 5 rallies). Everyone thinks it’s a dead cat bounce, but it turns out this time it isn’t, and the market rallies to ATHs (all-time highs). Of course, you don’t deploy your cash as markets soar because you feel “it must go down sometime because it’s a dead cat bounce!”

This is how the market and psychology can play with us (I am including myself here because I am not immune, nobody is). The good news is that there’s a “cure” for this: a long-term orientation. Regardless of whether it’s the bottom or a dead cat bounce, if a company is undervalued, it’ll show its true worth in due time. It definitely feels better to deploy all the cash at the bottom, but the only missing variable in this strategy is that nobody knows with certainty when the bottom is in.

The industry map was much greener than last week (granted, this was not very hard!):

Source: Finviz

The fear and greed index also improved, although it remains in extreme fear territory:

Source: CNN

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My additions this week and a potential sale