It’s a phrase that is doing the rounds on Wall Street and Fintwit in recent weeks, but what exactly does it mean?
Investing is scary sometimes, and when the market doesn’t appear to be going your way, buzz words and warning signals can often add to this often unnecessary stress.
The ‘buzz phrase’ of the moment is ‘valuation reset’ and, while many investors are using it in a positive sense, there is still plenty of confusion.
So, what does a valuation reset mean?
A ‘valuation reset’ is a phrase used by investors in relation to stocks that have seen massive growth in the past year and are experiencing a sharp drawback now in 2021.
Really, it is just a fancy word for a mini-correction. While the definition of a correction in the stock market is ‘a decline of 10% or more in the price of a security from its most recent peak’, a valuation reset is found, rather ambiguously, somewhere below this number.
Few will ever forget the correction that the stock market went through around this time last year as the realities of COVID-19 began to hit home. The S&P 500 (NYSEARCA: VOO) had taken just 6 days to fall 10% from its highs, while the biggest names such as Apple (NASDAQ: AAPL) and Amazon (NASDAQ: AMZN) were also plummeting.
We are not quite at that level yet though.
Why is everyone talking about a valuation reset?
There are 3 reasons:
- The first reason for all this talk is because last year’s high-growth stocks are not exactly going up right now. In fact, all the big names, including Apple, Amazon, and Tesla (NASDAQ: TSLA) are in the red year-to-date (YTD), though not quite in correction territory.
- Another reason is that the term has become popular among analysts on Fintwit and Reddit, and thus adopted by the millions of new retail investors who have entered the scene over the past year. The term’s popularity was further heightened by its acknowledgment from Ark Invest CEO Cathy Wood, who recently used the term in an interview with CNBC: “I do believe if [Treasury yield] rates were to take a sharp turn up, we would see a valuation reset and our [Ark’s] portfolios would be prime candidates for that valuation reset.” She is, of course, referring to Ark’s famous Innovation ETF (NYSEARCA: ARKK), which invests in forward-thinking tech companies, the main victims of the market’s recent sell-off.
- Finally, President Joe Biden’s $1.9 trillion COVID relief plan looks set to pass, and while many will be anxious to receive their checks, Wall Street is also anxious about the ripple effect this will have on the U.S. Treasury market, where the benchmark 10-year yield has risen sharply in recent weeks. Many are citing this as the reason for increased volatility among previously popular pandemic stocks, and conceding that their valuations are now being ‘reset’ due to outsized gains, accelerated by COVID.
What does a valuation reset mean for investors?
For the long-term investor, valuation resets can be very healthy and can give better entry points to stocks that have become very expensive. Although seeing your portfolio lose big gains can be tough, so far most of these stocks that are falling are still actually far above the levels they were at this time last year.
By sticking to a long-term investment strategy, it truly simplifies things. Think of this valuation reset like a discount sale on all of your favorite stocks. In 10 years, you won’t even remember this dip.
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