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  1. Home
  2. / Investing

To Divine the Direction of the Markets, Let's Go to California

For some reason, the fortunes of the Nasdaq 100 and interest rates have become intertwined.
By JIM COLLINS
Oct 21, 2021 | 11:00 AM EDT
Stocks quotes in this article: MSFT, AMZN, TSLA, FB, NFLX, TBT, QID

As we approach the 50th anniversary of the release of Led Zeppelin's seminal fourth album, it is time to highlight my favorite track on that masterpiece. No it's not Stairway to Heaven, but Going to California. I think it is the appropriate tune for this time, because the stock market has, indeed, gone to California from its historical home in Lower Manhattan. Nasdaq is the piper calling the tune for stocks. It's just that simple. So, forgetting for a second that Microsoft (MSFT) and Amazon (AMZN) are actually headquartered in Washington state, and that Elon Musk seems hell-bent on moving Tesla (TSLA) to Texas, we must focus on those Big Tech names and go to California to divine the direction of the markets.

For some reason, the fortunes of the Nasdaq 100 and interest rates have become intertwined. The reasoning seems to be that Big Tech valuations are based on heavy discounting of future events and yet-to-be-developed products (like robotaxis, for instance) and that lower interest rates should produce higher present values. Simply using the Capital Asset Pricing Model - I was one of a generation of analysts who grew up worshipping CAPM, when analysts valued companies based on antiquated concepts such as earnings and cash flow, not buzzwords like disruption and sustainability - that is very true. Lower discount rate equals higher fair value.

But what is not discussed widely is just how irrelevant interest rates are to Big Tech's actual day-to-day business. Tesla would be impacted by higher rates, to some extent, but for companies like Facebook (FB) and Netflix (NFLX) it makes absolutely zero difference to their day-to-day business. It really doesn't. People would waste hours on the mindless drivel produced by Zuck's election-meddling creation if the 10-year were at 1% or 10%. It doesn't matter.

But perception is reality, and rising interest rates are the one factor that I believe could derail Big Tech's Magic Carpet Ride of stock market gains. Well, guess what? Interest rates are rising. I am seeing the 10-year UST note quoted at 1.65% as of this writing (it was 1.66% a few minutes ago) and am surprised to see a "one-handle" on the 5-year UST note - 1.19%, and a "two-handle" on the 30-year UST bond - 2.12%.

I use Bloomberg's U.S. rates and bonds page as my guide, and it has some interesting analytics. Compared to one-month ago, the 10-year yield has risen 33 basis points and versus the year-ago date, it has risen 83 basis points. That's a move. Do not ignore it.

Why are interest rates rising? Inflation. It's that simple. As the Biden Administration and its laughable, Baghdad Bob-like spokesperson Jen Psaki, laughably fail to explain the causes of inflation or try to spin it as a "good thing," let me drop a little truth bomb on you. Rising rates of inflation are never a good thing. Classic economics tells us that the economy will structurally produce some inflation as population growth leads to household formation and an increase in competition for limited resources. Thanks, Adam Smith, but in the real world, inflation really hurts people.

It's a vicious cycle. Fewer workers lead to higher wages which leads to higher prices for finished goods, which makes employers have to raise wages so that their employees can afford to buy finished goods. Eventually, and we are at this point now, workers get so frustrated that they just stop working, and thus fewer workers lead to higher wages which...well, you get it.

So that's where we are. The Biden (or is it Brandon?) Administration is so hopelessly overmatched by any economic issues and so helplessly at the mercy of the far-left, Socialist wing of the Democratic Party, that there is no help in sight. A concerted effort by the Fed and Treasury could bring inflation to a standstill, but, come on. Be reasonable. We are dealing with Janet and Jerome here. Ain't gonna happen.

The feedback loop spins around and around like a well-worn copy of Led Zeppelin IV. Inflation -> higher interest rates -> inflation -> higher interest rates. Buy some (TBT) (iShares' Short US Treasury ETF) here to take advantage of higher interest rates (lower bond prices,) and layer some of the iShares' short Nasdaq ETF (QID) in with all your Big Tech winners to protect your gains.

When the levee breaks...make sure you have a raft.

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.

At the time of publication, Jim Collins's firm owned TBT, QID.

TAGS: Economy | ETFs | Federal Reserve | Interest Rates | Investing | Jobs | Markets | Stocks | Trading | Treasury Bonds

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