The Federal Reserve keeps rates lows and stocks get crushed? What's the deal? Aren't low rates great for stocks? You bet they are. But are they terrific for all stocks?
Nope. The stock market doesn't work like that anymore. The days when almost all bigger stocks traded together, lock-step, as part of an S&P 500 mix, has ended. Now we have old fashioned industrials and banks trading together, the former because lower rates will keep their businesses humming and the later because they make more money off your deposits.
Everyone else, especially tech? It's considered terrible as there is an expectation that unless the Fed does something to tamp down inflation, these fast-growing companies' stocks won't be worth as much as inflation impacts the value of their future earnings streams more than any other kind of stocks.
That's how you get the Dow Jones Average, chock full of industrials, blowing through a 1000 point milestone with zero fanfare as we saw yesterday and we have a real chance of having nine positive days out of 10 for the venerable index, an extraordinary streak especially when considering the pummeling that has taken place in the Nasdaq, where most tech resides.
Does any of this make sense at all? Yes. Will it be right? I don't think so. Can it make you money? No, not if you let conventional wisdom dictate your thinking.
First, let me set the stage of what happened yesterday and, while I know that a lot of the younger investors don't really care about bonds, you have to know why tech stocks are going down, and those are your first love, so you don't try to catch a falling knife.
At any given time there are scads of investors who buy the hottest of the hot stocks. Most of the time that means the stocks of companies that are going to have really great earnings year over year, which are exemplified by FAANG, or Facebook (FB) , Amazon (AMZN) , Apple (AAPL) , Netflix (NFLX) , and Google, now Alphabet (GOOGL) . The emphasis there though is most of the time. Money gravitates to which companies will have the biggest blowouts, tech or otherwise, and right now it looks like these industrials are going to report far better numbers than ever thought because demand is so amazing coming out of the pandemic and supply is meager, because few expected things to get so robust so fast. Making things even more exciting? Fed Chief Jay Powell isn't willing to put the kybosh on their earnings by slamming on the breaks to tamp demand.
So, if the Fed is saying party on industrials, go make some money, then big investors are going to flock to them. They, of course, have to sell something to buy these, as well as the now coveted shares of the banks which do well when the Fed keeps short term rates low - the ones they control - but longer term ones rise- as they have been. That means they bail from the Nasdaq's Peter to pay the Dow Jones' Paul.
Why is it so pronounced you might ask? It has to do with supply and demand. America has created trillions of dollars' worth of tech stocks. They are being printed like confederate dollars. But industrials and banks? Not only is there virtually no issuance, these companies have been buying back their shares for ages. Believe me, having been a trader at one point in my career, I think you could move a Dow stock like Caterpillar (CAT) three or four points higher with just a million share purchase. That's how little there's for sale above where it currently trades. So much has been retired and so many buyers are seeking it out.
The banks have been serial buyers of their stock whenever they are allowed to. So buyers of their stocks can move them, too, albeit with less ease because there are so many more shares.
But it would take billions of dollars of buying power to move any of the larger techs and almost all of them are net issuers not retirees of equity.
Will the love affair end? Will the hatred of tech ever stop?
For that we have to deal head on with a particular claim that Fed Chief Powell said yesterday when he decided to stay easy and continue his bond buying program to try to keep the longer-dated rates down.
Powell acknowledged yesterday that there is inflation building in the system, but it is transitory. As I mentioned yesterday, lots of bond holders think, given all the commodity price increases we have seen and all the stimulus that's coming, Powell is being either oblivious or a new breed of Fed chief who cares more about the fact that we are well below full employment and it is so worth waiting for the pandemic to end to see if the unemployed can get their jobs back. He has point blank said several times that minorities, African Americans and Hispanic Americans, have been disproportionality hurt, as have workers in travel and leisure, and he says the risk of fighting inflation with higher rates is far higher than the reward we would get.
I think Powell's right, and not just because the Fed has a not-so-hot history of moving too quickly too fight inflation that turned out to be transitory and ended up decking the economy almost all by itself, as his predecessor did in December of 2015 and he himself did with some ill-timed hikes in 2018. Wall Street never seems to recognize the negative power of a rate hike. Powell doesn't want that to be his legacy, not after he acted so aggressively a year ago to stop the economy from crashing. He was second-guessed then - the S&P dropped 12% the day after he slashed rates, in what turned out to be a fantastic buying opportunity. Yes, it was that wrong.
Moreover I think the sellers will be wrong now. Here's why. First, don't look now, the biggest source of inflation right now, oil, is rolling over and rolling over big time. Would a rate hike knock it over? I think that the Saudis took it up and now they are letting loose more production. Nothing to do with the Fed. Next, there are severe shortages in every single kind of plastic, the whole Poly and Ethyl complex and the producers are jacking up prices like mad. But that's because Super Storm Uri has knocked off a gigantic amount of supply. Our plastics industry is headquartered in Texas and Louisiana, and we have consistently underestimated the damage that's been done to these businesses where anywhere from 30% to 60% of production for everything from piping to shampoo bottles to milk containers to car parts and outdoor patio furniture, is still shut. Uri was a one in 100 year storm. Could Powell fix that with a rate increase? Two? Three.
How about lumber? It's doubled, making housing much more expensive than it should be. Would a rate increase create more trees and sawmills? No. But would a call from President Biden to his counterpart in Canada telling him we will scrap our tariffs and let's get a deal going, lower lumber? In a heartbeat. One phone call's better than one rate hike, let alone a bunch of them. Oh, and how about putting a tariff on all the lumber we are selling to China? Two birds with one non-Fed stone.
Semiconductors? Lots of this is supply chain, too. The Chinese double ordered when our companies were fearful. But, making matters worse, many of our companies chose to sent the chips they ordered from Taiwan on boats and there's a severe port labor shortage. Rate hike to the rescue? How about sending chips by cargo plane or using up more space on the coming commercial airline renaissance. How about solving the darned port problem? Powell could do more as a stevedore than he can do as a Fed chief to solve that issue.
I could go on and on. Copper? More ore coming from Chile and Peru and Arizona, just wait. Paint? Key ingredients that are offline about to go online. What almost every commodity bond sellers are rebelling against can come down in price VERY quickly, and they will be saying what the heck did I sell bonds for. What did people sell tech for?
So, while I agree with Powell when it comes to his imperatives, why not shoot for full employment, perhaps more important, I think he's going to be right on the transient nature of what everyone's freaking out about. In other words, they freaked out last year when he was right to cut rates, they freaked out now when he's not raising them. I think he's going to be two-for-two and the sellers, they are headed for an oh-and two record by betting against the man.