Sometimes, a lot of time is needed for investors to let go of habits and tendencies borne during a very different macro and monetary environment.
If following markets over the last two years has taught me anything, it's that it's very hard to wean many investors off the belief that cheap-money Fed policies -- and with them, the success of all the trades that worked well during a 12-year bull market featuring a friendly Fed -- are a birthright, no matter how clear it is that the Fed needs to keep the punch-bowl away for a while.
We saw this in the summer and early fall of 2021, when Treasury yields remained at rock-bottom levels and both retail and institutional investors kept bidding their favorite growth stocks to nosebleed valuations, even as signs kept mounting that inflation wasn't transitory. And we saw it again in July and August of last year, when lower energy/commodity prices and some Jerome Powell comments that were mildly less hawkish than feared helped fuel manic buying of both bonds and high-multiple risk assets.
Over the last month, bonds surged again (at least until Friday) as buyers took heart in data that pointed to moderating (but not collapsing) inflation. Meanwhile, amid easing financial conditions and following the end of tax-loss selling, investors once more piled into a wide array of expensive and/or speculative risk assets -- from meme stocks and cryptos, to high-multiple cloud software and Internet stocks, to cash-burning electric-car and fuel-cell plays.
But as Friday's hot jobs report drives home -- and as Powell emphasized during his Wednesday press conference -- we still have a structurally tight labor market that's driving high wage growth (and with it, services inflation) in many sectors. And this, together with still-fairly healthy consumer balance sheets, is making consumer spending a lot more resilient than what those who have been predicting a big recession and quick Fed pivot had expected.
Also, while recent inflation prints are encouraging in some ways, they benefited from energy and goods deflation that might not last. Oil prices have been range-bound after tumbling in November and early December, and prices for many consumer goods fell in late 2022 due to two one-time events: normalizing supply chains and inventory-clearing efforts by retailers.
What's more, recent data point to housing demand and prices -- under pressure over the last several months as mortgage rates soared -- stabilizing as financial conditions ease and inflation-adjusted wage growth improves. And as many others have noted, China's reopening could lead some goods and commodity prices to reignite.
Meanwhile, though some investors viewed Powell's Wednesday commentary as less hawkish than expected (strong echoes of July), it's pretty clear that Powell and the Fed remain committed to keeping the Fed funds rate at elevated levels until/unless inflation falls to pre-Covid levels and stays planted there (something that, for reasons already discussed, I think is unlikely to happen anytime soon).
Yet in spite of all this, bond investors have priced in a slew of rate cuts for the next 18 months, with initial cuts remarkably priced in for the second half of 2023. As both the yield curve and breakeven yields demonstrate, many bond-buyers have once again convinced themselves that inflation is transitory.
And with some help from short-squeezes and positioning-driven action among institutional investors who were underweight growth stocks to begin the year, we've had a fresh bout of speculative euphoria for risk assets, with call-buying among retail investors approaching its 2021 highs.
Making matters worse: As reports from the likes of Microsoft (MSFT) , Amazon.com (AMZN) , Alphabet (GOOGL) and Apple (AAPL) drive home, such speculative euphoria has occurred during a fairly mixed tech earnings season. While conditions aren't as dire as the mega-recession callers might have one believe, there are clearly demand headwinds in areas such as PCs, consumer electronics, corporate IT spending and online advertising that give tech investors additional reasons (on top of inflation and a hawkish Fed) to be valuation-sensitive right now.
All of this suggests what we've seen isn't the start of a new bull market, but yet another counter-trend rally fueled in large part by equity and bond investors eager to believe that the return of the cheap-money era is right around the corner. And while it's possible that some popular, beaten-up, tech stocks have already bottomed -- particularly with the economy holding up better than feared -- I think many of the frothiest assets are likely to see new lows before the dust settles, and that a lot of less-frothy stuff is prone to get hit to varying degrees along the way.
In some ways, the tech sector's latest rally brings to mind not only last summer's rally, but also the counter-trend rally that took place in Jan. 2001, amidst the Dot-com bubble's implosion. Back then, with an assist from some better-than-feared earnings reports, the Nasdaq rose 25% from early to late January, after having been nearly cut in half since early September. But this rally merely set the stage -- as Internet and telecom bankruptcies mounted, and enterprise IT spending and telecom capex plummeted -- for the Nasdaq to drop another 40% between late January and a short-term bottom set in early April.
History never fully repeats, and I doubt the Nasdaq will see a drop as dramatic as what happened in the winter and early spring of 2001, particularly since a more limited number of companies obtained truly absurd valuations this time around. But 40%-plus and maybe even 50%-plus drops aren't out of the question for the most richly valued and speculative stocks, with various other tech stocks seeing more moderate declines in the process.
This feels like a pretty good time to have some shorts or hedges on one's book -- or barring that, to keep some cash on hand until we get another washout in the froth and more attractive equity prices emerge.
(GOOGL, MSFT, AMZN and AAPL are holdings in the Action Alerts PLUS member club . Want to be alerted before AAP buys or sells these stocks? Learn more now. )
