What happened
A broad cross-section of stocks tumbled again on Tuesday as market watchers focused on the Federal Reserve Bank's ongoing battle against inflation. Over the past several days, a couple of strong economic reports have increased concerns about the trajectory of an already overheated economy.
With that as a backdrop, shares of Amazon (AMZN -1.14%) fell 2%, Alphabet (GOOGL 0.35%) (GOOG 0.37%) tumbled 2.4%, and Shopify (SHOP 0.14%) had slumped 4% as of 12:19 p.m. ET.
A check of all the usual sources didn't uncover any company-specific news behind the sell-off, which suggests investors fear that the Fed might not be able to slow the pace of rising interest rates as quickly as they had hoped.
Image source: Getty Images.
So what
Mixed messages on the economy are giving investors a case of whiplash.
Last week, after several economic reports had indicated that the pace of inflation was declining, Fed Chair Jerome Powell suggested that the central bank might be able to slow the pace of interest rate increases. However, investors fear that pronouncement could be short-lived.
The monthly federal jobs report on Friday revealed that the economy created a higher number of positions than expected during November. At the same time, wages increased much more than expected. Furthermore, the Institute of Supply Management released is latest read on the services sector on Monday, which revealed that business activity in that area had expanded for the 30th successive month. Both of these reports suggest a booming economy -- though that's not as good as it seems at first glance.
Normally, investors would rejoice at strong economic data. Unfortunately, the economy is a bit too strong, which is fueling inflation. Consumers and businesses alike suffer in an environment of rising prices because everything is more expensive.
To combat inflation, the Federal Reserve Bank raises interest rates. This, in turn, makes it more expensive to borrow money, causing people and companies to spend less -- or so the theory goes. When spending decreases, demand declines, and the price of everyday staples begins to fall. So by increasing interest rates, the Fed is working toward an eventual result of lower prices. The central bank is forced to walk a tightrope between slowing inflation and trying not to tip the economy into a recession, which could happen if economic growth slows too quickly.
Unfortunately, these latest reports show that the economy -- and therefore inflation -- continues to grow, as yet unfazed by the Fed's campaign of rising interest rates.
Now what
The robust data in these reports suggests that the Fed won't be able to slow the pace and tenor of its interest rate increases as quickly as Wall Street had hoped. This further indicates that an environment of higher interest rates will be with us for some time to come.
The current conditions represent challenges for our trio of companies.
- Alphabet makes the vast majority of its revenue from digital advertising. Marketing budgets are among the first to get the axe in times of economic uncertainty, which will weigh on Alphabets' results.
- Amazon is already dealing with slowing e-commerce growth and tough comps in the wake of the lockdown-induced growth spurt during the pandemic. An economic downturn could also weigh on its cloud computing business. Add to that even slower consumer spending, and things could get rocky.
- Shopify is suffering a similar slowdown in its software-as-a-service (SaaS) business, which provides tools to merchants to help them sell their goods and services online.
For investors holding for the long haul, these developments should be viewed as transitory in nature, and they most likely won't affect the overall trajectory of these businesses. Each company is a leader in its field and has survived previous downturns and periods of economic insecurity.
Furthermore, if you wish to view the glass as half full, take heart. These stocks are selling for a significant discount from their prices of just one year ago, with multiples to match. Amazon is clearly in bargain-basement territory, selling for just 1.6 times next year's sales. (For context, a reasonable price-to-sales ratio is between 1 and 2.) Alphabet and Shopify are slightly pricier, selling for 7.4 times and 4.0 times next year's sales, respectively -- but these valuations are lower than either has been in years.
For investors with the appropriate investing time horizon and long-term outlook, buying shares of these industry leaders while they're on sale will seem like a genius move three to five years down the road.
