While the broader market grapples with a potential secular bear, savvy investors are unearthing generational opportunities in deeply discounted stocks, with former S&P 500 member Etsy emerging as a prime example of a ‘fallen angel’ ripe for a rebound, backed by historical outperformance and strategic innovation.
The year 2022 marked a significant downturn for the S&P 500, with the index experiencing its worst performance since 2008, declining by 19%. This challenging period followed a record high of 4818.62 in January 2022, prompting some experts to issue dire warnings for the future of the market.
One such expert, Michael Markowski, an algorithm developer known for forecasting significant market crashes, has updated his forecast for the S&P 500. He predicts a bottom at 1090.90, representing a staggering 77.36% decline from its January 2022 peak. Markowski also accurately predicted the end of the secular bull market in January 2022, and the beginning of a new secular bear market, a period typically characterized by declines ranging from 47% to 85%.
Despite these broad market anxieties and warnings of a potential third Great Depression in 2023 due to the Federal Reserve’s policies, some individual stocks, particularly those that have experienced significant declines, are beginning to show signs of deep value. These “outcasts” from major indices often present unique opportunities for long-term, disciplined investors.
Etsy: A Former S&P 500 Star Now Poised for a Comeback?
Etsy (NASDAQ: ETSY), the popular online marketplace for handcrafted goods, experienced a dramatic rise and fall. After being included in the S&P 500 in September 2020, its stock peaked in late 2021 before plummeting. By the time it was removed from the index, it had dropped roughly 80% from its all-time high, and currently remains down by 76%.
This kind of dramatic decline often causes retail investors to panic and institutional investors to withdraw support as the company no longer fits large-cap mandates. However, history suggests that these moments of market neglect can create significant long-term value.
Historical Precedent: The “S&P 500 Outcasts” Phenomenon
Research by Rob Arnott of Research Affiliates highlights an interesting pattern: stocks removed from the S&P 500 tend to initially underperform for several months, but over a five-year horizon, they often outperform the broader market average by several percentage points annually. This outperformance stems from shares becoming excessively cheap, setting a low starting point for future returns. Arnott’s findings, published by Research Affiliates, suggest that the market’s initial rejection creates a fertile ground for patient investors.
Etsy’s current position as an “S&P 500 outcast,” trading at a deeply discounted valuation, aligns perfectly with this historical pattern. Its shares now trade at a price-to-free-cash-flow valuation of less than 14, one of the lowest in its decade as a public company.
A Valuation Story: Free Cash Flow and Aggressive Buybacks
Despite its stock performance, Etsy’s underlying business has remained resilient, consistently generating substantial free cash flow. Recognizing its undervalued state, management has been aggressively buying back shares. In just three years, the company has reduced its outstanding share count by an impressive 21%.
This strategy mirrors that of eBay (NASDAQ: EBAY), another e-commerce platform that struggled with growth but used its strong cash flow to reduce shares outstanding by 33% over five years. Despite an average revenue growth of a paltry 2.5% over three years, eBay’s stock surged 141% in the same period, demonstrating how share buybacks and a cheap starting valuation can drive significant returns even with modest growth.
Innovation as a Catalyst: The ChatGPT Factor
One of Etsy’s primary challenges has been the flattening of active buyer adoption. However, a significant potential catalyst for renewed growth recently emerged with the integration of ChatGPT. Etsy is reportedly the first platform to integrate with the AI chatbot, allowing users to theoretically find and purchase items directly through ChatGPT, as announced by OpenAI.
If this integration marks a new paradigm for online shopping, it could provide the much-needed boost to Etsy’s adoption rates and overall growth, helping the company to break out of its recent disappointing performance. Wall Street analysts are already predicting a significant gain of 70% for Nerdy (NYSE: NRDY), another online learning portal, indicating a general positive sentiment towards tech-enabled growth stories in 2024, despite broader market fears.
The Broader Market Perspective: Navigating a Secular Bear
While specific stock opportunities like Etsy present compelling cases, it is crucial for investors to remain aware of the broader market environment. Michael Markowski’s long-term forecast of a secular bear market, with declines potentially mirroring the 85% drop seen in the second Great Depression, underscores the need for caution and robust investment strategies.
Even after its 19% decline in 2022, the S&P 500’s forward price-to-earnings multiple remained above its historical average, according to Barron’s, suggesting that the market still has room to fall if investor sentiment weakens further. Equity analyst estimates, as noted by David Rosenberg of Rosenberg Research, may not yet fully reflect the realities of a possible recession. This reinforces the importance of a defensive posture and careful stock selection.
However, some analysts like Tom Essaye of Sevens Report Research, see reasons for optimism, noting that while not historically cheap, the market is no longer as overvalued as it was at the start of 2022. The potential for a “soft landing” could lead to multiple expansion, contrasting with Markowski’s more extreme bearish outlook.
What This Means for Long-Term Investors
In a market characterized by such divergent forecasts, a disciplined, long-term investment strategy focused on fundamental value becomes paramount. Rather than chasing hyped-up stocks, investors can find “generational value” in companies that are deeply discounted, possess resilient businesses, and have clear catalysts for future growth.
Whether it’s a dividend king like Colgate-Palmolive, trading at a 20x free cash flow and a 2.5% dividend yield, or a former S&P 500 component like Etsy leveraging strategic buybacks and AI integration, the current environment offers distinct opportunities. The key is to look beyond short-term market noise and the psychological impact of declines, focusing instead on underlying financial strength and potential for long-term recovery.
Navigating a secular bear market, which can last for 9 to 13 years, requires understanding the psychology and nature of such periods. It’s a time when astute investors, focusing on fundamentals and historical patterns, can position themselves for significant returns when the market eventually recovers.
