— The gorilla, of course, is Fed policy and rising interest rates.
— For certain segments of the market (Big Tech/The Innovators in particular) it rightly looms large.
— For the rest of the market Wednesdays action was an exercise in ‘sawing sawdust’, reacting in a predictable way to old news.
— The market sends a clear message. Higher rates are the 80 pound gorilla for most stocks.
The Fed Gorilla Is Out Of Its Cage
Yes they have been talking about letting the beast loose for many months but now, after much talk, it seems to be a reality. The evidence is clear after Fed chair Powell’s hawkish comments following the December Fed meeting punctuated by those coming from Fed governor Christopher J. Waller late last month:
“I don’t see any reason to delay balance sheet adjustment,” he said. “I think we can go much sooner and much faster” than the Fed did in 2014, he added, as our colleagues at MarketWatch reported.(Barron’s)
Today’s (1/5/22) release of the minutes of the December Open Market Committee meeting was the coup de grace … a confirmation that all this tough talk is for real. Red ink was everywhere to be seen. The biggest loser was the tech & innovation heavy NASDAQ, down 3.34%.
The S&P 500 with 25% of its market capitalization, roughly $10 trillion on December 22, 2021, in six companies (Apple, Meta Platforms, a/k/a/ Facebook, Alphabet, Amazon, Netflix and Microsoft) was down 1.94%. BTW, these are all terrific companies. They just might have gotten a bit pricey. Finally in large cap land the tech-light Dow was only down 1.07%.
Nonetheless it was a risk-off day. Small caps took it on the chin with the Russell 2000 down 3.3% and cyber-currency fav Bitcoin at $43,544 down 6.04% (A/O 8:10 CST 1/5/22).
Higher rates present a problem for certain market segments
When the earnings yield (price divided by coupon) on a US treasury note is 1% … or 100 times earnings with no growth, the sky is the limit on how enthusiastic investors might price a potential high growth equity. The calculus changes dramatically when that rate moves to a guaranteed 3% (33x earnings). The higher the rates go the more valuation becomes an issue. I look at Cathie Wood’s ARK Innovation ETF (ARKK) as a proxy for what is happening here. The fund peaked at the height of a speculative burst coming off the Covid bottom in the spring of 2020. The price was$159.70, the date February 16, 2021. It closed at a new 52-week low today at $86.12. Many of its disruptive growth components (a la Teledoc and Zoom) have fared far worse. Incidentally, the yield on the UST 10-year note hit .99% January 27, 2021 (20 days prior to the peak in the Ark fund).
One other point: there was an assumption and mantel of safety applied to these names because many of the companies were assumed to be able to grow dependably even in the toughest times. They were bulletproof. Some actually appear to be. From my perspective bulletproof would appear to be hard over the long term (Eastman Kodak and Polaroid) which takes you back to the question of what do you pay?
The media saws sawdust … the whole market gets slammed
By ‘sawing sawdust’ the media goes into high gear, fretting or trying to get us to fret about the Fed draining liquidity from a banking system that is flush with liquidity. This a perpetual worry and they saw on it every chance they get. To give you a little perspective the Fed balance sheet assets (holding of government securities and mortgage backed securities) were less than $1.0 trillion in 2008. It ballooned to $4.5 after the crisis. The Fed started to reduce it then came Covid-19. It stands at about $8T today. There is no emergency requiring it to be that large. The economy is doing great. The balance sheet probably never needed to be that large. The only way that this is a problem is that the media will work to convince you it is … bad news sells. Of course if you own those high multiple stocks, maybe that’s a problem but it is not a problem that will destroy the economy or throw us into recession.
Today’s market was an equal opportunity destroyer. I have to view it as a pause that refreshes for a good many stocks away from big tech … the also-rans (value, cyclical, mid cap and small cap … the losers of the past bifurcated market). I am still not certain where bitcoin fits into this picture. It seems to trade more like a stock (a stock with zero earnings) than a currency.
The market appears to sending a clear message
THE GAME HAS CHANGED … away from growth at any price to real growth and profitability NOW. It would seem that we may be in for substantial, deficit-spending-fueled earnings growth from many companies forgotten in the market’s rush toward large cap, dependable long-term growth and new technology. The ‘haves’ and ‘have-nots’ are changing places.
As I said in my last post (Covid Omicron in rear view mirror — Will we be so lucky with Fed policy? ) Fed policy and interest rates are likely to become the market and media’s next great obsession. Don’t let it become yours.
What’s your take?