Where are we in this bond-related selloff? Are we one-third through? Two-thirds? Or are we where we need to be to start buying?
As I have said I have studied all the rate scares we have had in the last couple of decades and this one is pretty much following the form of those where the Fed feels pressure to raise rates off a very low base.
These scares all have the following in common:
- Inflation by some measures seems out of control. In this case it is lumber, which has doubled in a year; copper, which is really Chinese demand, up above $4; and oil, which is north of $60. They are visible and they are saying the Fed must act.
- There are a considerable number of stocks that have been created that do best with stable rates like we have and these stocks have become toxic because they are being viewed as dangerous places as they have no real earnings or sales. These kinds of stocks need low inflation for a long-term pay-off and they aren't getting that.
- The Treasury is under assault for spending too much. Here we have the huge stimulus package coming at a time when the pandemic seems to be running its course because of science. But spending is often at the heart of these scares.
- We get shortfalls from the higher rates that the Fed doesn't control.
Now, before I get to each one, I want to remind you that all of this is happening in a bond-market vacuum. If you read Warren Buffett's letter this weekend you can see unbridled capitalism and how little these four points mean. They are noise to him, and I don't even think he hears it although his jarring $11 billion write-down of Precision Castparts is a reminder that no one is immune to "the moment." Buffett paid $32 billion for this excellent aircraft parts company six years ago. It was a high price at the time, too high as Buffett admits.
Still, the takeaway of Buffett's letter, as always is that if you take a long term view things will work out on balance and this time, he did not chastise anyone for trying to do it at home. Thank you.
Now let's deal with the matter at hand. There are many investors, particularly new investors, who do not get the interrelation between bonds and stocks. Too make it easy there are three intersections. First, rates going higher make for competition to stocks and some would say that already the average stock's dividend stream is threatened by the bond fixed-income stream because of the "big" move in rates. I think this is canard. Bonds are still very unattractive. Again read Buffett if you disagree. Second, interest rates, per se, are a signal of the future and the future is that we are going to have inflation and inflation is bad for stocks. Explaining why it is bad is a little like explaining why a football team is bad. It loses a lot. You lose a lot in stocks when inflation's bad. The third is the hardest: ticks up in yield trigger algorithms that drive down individual growth stocks while stabilizing cyclical stocks. The latter can't go higher because of the downward pull of S&P futures from big macro funds that want less exposure. But the cyclicals are in favor and, because of years of dormancy, there are very few of them and they don't equal even a tenth of the growth stocks out there. They can't lead.
So, where are we? I don't want to dismiss the most bullish of cases: the last ten minutes of Friday were horrendous and yet rates didn't go higher so it is possible we are further along than we think.
But I think that is too optimistic. We haven't passed the stimulus yet. The Fed hasn't been pressured for what happens when that money gets distributed and we are fully vaccinated. Only the variants, the malicious variants, can derail the vaccination plan and I think that they won't be as serious only because our scientists are one step ahead of the posse now.
So what happens then?
I think that when we have these scares no one has enough money on the sidelines to take advantage of them and your co-shareholders are your enemy. They don't want to sit tight, a la Buffett, perhaps because they are in options or because they are on margin or because they think the market is rigged or they don't understand the bond market interplay.
What they don't understand is that even though rates are low even a minuscule move versus the 13% of forty years ago or the 7-8% of so long in the 90s, means that, on a percentage basis big money get scared.
Plus, we are not yet at the moment when Jay Powell gets asked a question about what happens when everyone gets vaccinated and he says "you know what, we took rates to zero a year ago, it's time to let them go higher."
Until you hear that you have to keep some powder dry. Notice I didn't say "if you hear that." At a certain point it would be pointless to keep rates down if the economy is growing and ten million people get hired back.
So, the long answer is that this scare will not end until Powell breaks with his current view.
That means we could have some real pain ahead for some stocks.
What kind of stocks?
Five different kinds.
First, there's the companies that did well last year that might not do as well this year. You are seeing this right now, in real time, play out with Costco (COST) and Walmart (WMT) . I know some are gripped with the higher labor costs these companies are taking on. Others are concerned that now non-essential retailers are back these companies have to be doing worse.
I say that's why you have already had such a swift decline. Walmart is only 13 points up from where the pandemic began. Do you think it is worth less than that moment even as so much of its competition has now been destroyed? Of course not. Same with Costco. These are two amazing companies with stocks that will go higher over time because they make so much money. That's not even fathomable right now for some of the sketchy holders. So you can bet that, like a Clorox (CLX) , these companies will see their stocks flirt with charts that would indicate that there's been no value created. We are buying them for Action Alerts PLUS because it is simply untrue that they are worth less than when the pandemic began.
So, I am saying that some stocks have already neared where they are going to go and just need one more swift leg down that might happen too fast to buy.
Then there is a second cohort, the Salesforce (CRM) /Workday (WDAY) group. These are companies that are beginning to really have some amazing sales at a time when it's pretty unimaginable for that to happen. These are deferred revenue businesses so most could not see the breakout both companies had versus the last few quarters. Are the selloffs absurd? Not at all. Not when rates are busting higher. The big worry here, if you use the 2015-2016 paradigm, will be when one of this cohort misses and blames the economy the way LinkedIn did back then. I don't see that happening so the declines of 30-40% are not going to happen, IMO. Which means, again, that this group is a buy when we have the swift leg down that I am expecting, when Powell is pressured too heavily and says the magic words. The stocks will bottom ahead of that, but we aren't there yet.
Third group: companies that are SUPPOSED to benefit from higher rates. I don't want you to even think for a second that they actually will. The only stocks that go up in a scare like this are pure commodity stocks like copper companies and they go up until either China, the main client, stops buying or we get more mines to open, which is happening now. The stocks that people SAY will go up will be the cyclicals and the banks but that's a canard. When rates go higher and the Fed doesn't follow banks make a little extra on your deposits but inflation will obscure that until earnings are reported. The cyclical rally will not last because too many people will worry about missed numbers because rates are going higher. These companies are crummy leaders anyway. There are too few of them.
Fourth, higher yielders. These have to come down to levels where the yields are even higher before they are less risky to own. You can watch Pepsi (PEP) or Coke (KO) or Pfizer (PFE) or Merck (MRK) and you can see what's happening. American Electric Power's (AEP) a good pain proxy, too. You can't see it, but you know it is happening. I like this group right here because it is now starting to overcompensate. That's because there's a reshuffling toward stocks that do better when the economy opens -- only a handful -- and these stocks are the fuel for that move. Lower still, though, is the watchword, but not much lower.
Then there is the final group, the newly minted companies and the companies based on the hope of EV or alternative energy or SPACs that have found companies but the SPACs are overvalued relative to the companies -- Churchill Capital IV (CCIV) - Lucid Motors being front and center. I don't have any idea how low these can go. There are too many of them. They aren't followed. They are truly part of the Wall Street hype machine. Some can hold up because they have a good concept: check out Fisker (FSR) . But it is case by case and a lot of money is still to be lost here.
I know that I am not tracing out a scenario that makes things worth buying. But I do think that the group that bottoms first will be the Salesforce high-growth with earnings sector. Why? Because every scare ends with these stocks going higher, which is why you have to pay attention to them and start buying them, actually now as they tend to anticipate everything I just wrote.
Remember, I am not trying to give you hope, just history. But history is almost never wrong. I think it won't be wrong this time either.