That may be the most important word right now in describing what's working in the stock market and what's dragging us down. We just don't think about it enough because it takes a strategist who knows individual stocks and sectors as well as top down analysis and there aren't many of them around.
I like to find the commonality between what's going higher and what's going lower and contrast that with the conventional wisdom because the latter is so often wrong.
Right now we are gripped with a rotation of unfathomable proportions where banks and industrials can seemingly do no wrong and techs do no right. We often hear that's because banks benefit from the yield curve where they can charge more for loans and do more with your assets with your cash balances. The first is, for the most part, correct although the movement, no matter how much it is talked about, really hasn't helped the banks. It's not like the "prime" is going up and if you tried to get a mortgage of late it's pretty much the same rate as it was eight weeks ago before the "big" run up in rates. Banks don't really start making big, risk-free, money until the Fed moves short rates higher so this move is really in anticipation of that. We are also told that the cyclicals are going higher because of the coming boom from the Great Reopening. I like that point but it doesn't justify these kinds of outsized moves.
Meanwhile the collapse of tech's based on the fear of the fear of inflation which erodes the value of all long-dated paper assets. That's demonstrable albeit confusing to many of the younger investors because there's a lack of education about the history of the market that you often used to be able to get from talking to an actual broker who knows the history as explained to him or her by their firm.
Instead, what we have is a mishmash of thoughts by people who struggle to understand what's happening and I can't blame their confusion although I can blame their insistence on being right in the face of their lack of education. For example, repeatedly I am told that the techs should be going up because they don't need to borrow so what does it matter to them if rates go higher, so therefore they should be bought.
That's just not right. It has nothing to do with that whatsoever. Every company worth its salt is borrowing at ridiculously low rates anyway and even a 100 basis point rise would mean little. It's about inflation and the Fed's lack of desire to raise rates to head it off.
I am with Jay Powell when he talks about the transitory nature of inflation, right now. Someone at the Fed - maybe Jay himself? - has done enough homework to realize how quickly prices can collapse when companies that are pumping out vast supply to meet demand finally tip into equilibrium. Semis, plastic, lumber - with help from Canada - they can easily nosedive on their own volition. Even oil can. Right now the Saudis are keeping oil tight by holding back their supply - isn't it amazing how powerful this little country has been for 40 years now? But American technology is accelerating Permian production with fewer rigs so oil could plunge to the low fifties in a heartbeat.
So what defines the exaggerated reality?
The big moves behind the industrial stocks have more to do with how few there are and how few shares there are of the ones that trade. Take some classic examples: farm and construction equipment. There simply aren't that many publicly traded stocks in this cohort so the ones that are regarded as the class of the field are moving up in advance of a boom and are moving up with ease.
The most obvious example? Deere (DE) is a fabulous company that has, historically, missed estimates or offered forecasts that take numbers down. But the last few quarter have been excellent and the forecasts been raised. The free cash flow here has exploded higher.
That's all terrific but can it explain how the stock trades at a multiple equal to many of the faster growing tech stocks even as it is, in the end, in a cyclical business? Yes, because there are so few rivals - really only Agco (AGCO) - and so few shares, Deere has taken its share count down by a 25% in a decade from 412 million to 316 million. Agco, too, has been a voracious buyer of its stock.
The rails are right in our face today. We are losing one of the last independent American rails with Canadian Pacific (CP) buying Kansas City Southern (KSU) . That leaves us with just Norfolk Southern (NSC) , CSX (CSX) and Union Pacific (UNP) , which we own for Action Alerts PLUS. I bet all three are now worth more. Can you imagine if there were only three software as a service companies, and how much they would be worth?
How about engines? Just Caterpillar (CAT) and Cummins (CMI) , with Caterpillar reducing its share count from 645 million in the last decade to 544 million and Cummins from 193 million to 149 million, in retrospect all prescient buys. How about customers? While United Rentals (URI) doesn't buy CAT machines, it's taken its share count down from 94 million to 72 million in the last decade.
I could perform this same exercise for almost every industrial and you would see the same dynamic. If you add on the fact that many of these companies are in the S&P 500 so they are bought by rote from the torrent of capital invested in index funds and you get another source of endless share demand.
So, this move's so exaggerated not just because the Great Reopening but also because of the Great Scarcity of shares in the industrials. The banks are harder to understand. It's as if the market finally recognized that they have more earnings power than people realized and nothing more than that. Scarcity of lower multiple stocks? I think it makes sense.
Now how about the other side of the trade? The amount of new, public, tech and biotech companies is preposterous. There's simply no end to them. Many of them are second rate posers. Others are just in crowded spaces - software as a service for customers, or internet of things, or parts for electric vehicles, or fintechs. You can't even keep track of them. The share counts are endlessly growing as are their floats as insiders get their chances to sell, and lordy do they take them.
Don't forget the expansion has allowed pretty much every single unicorn to file or hit the IPO chute. Their exclusion from the public market had been, in retrospect, a godsend for the Nasdaq.
Add on the SPACs and you get an amount of supply that is drowning the market. You need the endless pumping to stop before you get a true bottom which is another reason why I keep saying we aren't there yet. I have always viewed the market as driven by supply and demand and there is a lot more demand for industrials with limited supply and you can't possibly put away enough of the techs without a closing of the spigot. There are very few funds like ARK (ARKK) out there with mandates to buy the longest-dated assets available.
You see this same logic play out everywhere. It's the scarcity that's driving up the fixed number of bitcoins versus the limitless amount of global fiat currencies. The scarcity of the non-fungible tokens drives the success or the hype of the move, propelled by the treasured blockchain technology.
There are other possible endings to the rotations. Mergers among techs. Disappointment in cyclical and financial earnings. Additions of techs to the S&P. It will have to be some combination of reduction in new shares and a belief that inflation really is transitory to turn around the flow of funds. It can happen. In fact it usually has by now but the extremes of the percentage change in rates and the preposterous numbers of SPACs with no market discipline given the ease with which they are produced explains more than anything related to the Fed. There's just not enough scarcity or new money coming in to absorb so many of these new stocks and too few ARKs of the world to think so long-term or wrong-term depending upon how things come out.
So we wait to see if inflation is, indeed, transitory or the tech/biotech spigot closes, or both. Until then I would be a seller of the plethora of tech into strength and a buyer of the industrials into weakness because I do not want to bend against the flow.