Right now, the market is in free fall.
Interest rates are surging and investors are quite literally running for the exit.
You can clearly see the inverse relationship between the S&P 500 (SPY) and the 10-year Treasury (IEF) in the chart below. As interest rates rise, stocks dip lower and lower:
Data by YCharts
And with inflation remaining at suborning high levels, we can expect many more rate hikes before things finally stabilize. The Fed recently made this clear and it is causing investors to lose hope.
But before you panic and sell your stocks, you must remember a few important things:
- It is impossible to time the market because it is a forward-looking machine.
- The recovery is always unexpected and most gains happen in a few days.
- Valuations are already historically low, pricing materially higher rates.
- Not all businesses suffer from higher interest rates to the same extent.
- Some businesses even benefit from this uncertain environment.
So it is not as simple as saying that “interest rates will rise, and therefore, stocks will drop further.” If it was so simple to predict the market, we would all be billionaires.
Generally speaking, it is not possible to time the market, and beyond that, not all stocks react similarly to rate hikes since they have different balance sheets, they are priced at different valuations, and they also react differently to inflation.
The key in today’s environment is to buy businesses that enjoy three things:
- Low Valuation: They need to be already so heavily discounted that you enjoy a significant margin of safety if interest rates keep rising.
- Strong Balance Sheet: Low leverage and well-laddered debt maturities so that the profitability of the business isn’t materially impacted by rate hikes.
- Benefits from the High Inflation: It allows the business to hike its prices and grow its revenues at a faster rate than its expenses.
And believe it or not, they are surprisingly many such businesses. Of course, they could still drop in the near term (we don’t a crystal ball), but in the long run, you would expect such resilient and undervalued businesses to deliver strong returns.
In what follows, I highlight two such stocks that I have been accumulating following the recent correction:
KKR & Co. Inc. (KKR)