AVUV - Another Trip To The Crossroads... We Are Not Holding Our Breath!
2023-03-08 06:30:00 ET
Summary
- Every time Jerome Powell speaks, the Fed Open Market Committee (OMC) meets, the OMC minutes are released, and the market goes into a state of suspended animation.
- After a year of consistent messaging and rapid tightening, you would think the policy message would be clear.
- "Higher for longer" even if the jobs data (released this Friday) turns out better than expected (i.e., unemployment on the rise - for some a "best-case" scenario).
- Step back off the ledge. Fixed income competition for equities is still puny even if rates continue to rise. The market ex the FAANGs+ still looks very attractive. Actually, the market including FAANGs+ looks very attractive versus the 10-year Treasury.
Powell speaks... the market cringes!
This is not a new phenomenon. In the 1970s, it was the release of money supply data and the pronouncements of "doom and gloom" gurus like former Salomon Brothers chief economist (aka Doctor Doom) Henry Kaufman that moved markets. "On the morning of August 17, 1982, he accurately predicted the market had bottomed out which led to a huge rally that day in both stocks and bonds that was to be the beginning of the longest bull market in history."
To be fair, the bottom Kaufman called in 1982 was the bottom of a cyclical bear market. The actual market low of the 1966 secular bear came in December of 1974, when the S&P 500 closed at 62.28. By the time Kaufman made his call in 1982, the S&P had been as high as 143.02 (up 126%) . At its low in 1982 (102.42), the index was still up a healthy 67%. Most of the time between 1974 and 1982, he was a bear on the back of soaring inflation and interest rates... both very much worse than we have seen recently.
A year of consistent messaging... "Higher for Longer"
Like Kaufman, today's markets seem to hang on every syllable out of Fed Chairman Powell's mouth. As such, the media has been full of commentary and speculation about how he will address the questions of Congress over the next two days... building suspense over, to what in my mind, is a non-event. There is no reason to assume any change. Rates will be going higher for longer until we slay the inflation dragon. That will be his reaction even if we get a surprise bump in unemployment on Friday. The only thing that might change my thought process would him possibly raising his target level for what he would consider to be a tolerable rate of inflation. This now stands at 2%, which I believe is an unrealistic target. In the end, "full employment" - the Fed's other mandate - will move that target higher. With the 10-year US Treasury note trading at a sub-4% yield and Fed funds near 4.75%, we are still below the historical average levels - levels that the economy was able to endure quite nicely over the past 50 years... 5.33% on the federal funds rate and 5.9% on the 10-year.
Step back off the ledge, please
As we all can agree, rising rates can put pressure on the economy (maybe take us into recession) and they represent competition for equities. Fundstrat Global Advisors' Tom Lee provided some interesting work recently when he calculated the P/Es of the general industry classifications (GICS) of the S&P 500 and combined them with those of the FAANGs+ ( META , APPL , AMZN , NFLX , GOOG and MSFT ). What he found, based on 2023 estimates, was the FAANGs+ carried a forward P/E of 22.7 times earnings. Everything else was cheaper... in some cases, much cheaper. Excluding the FAANGs+, the P/E average for the GIC groups was 14.8 times, and with FAANGs+ 16.1 times. Based on these numbers (even if estimates are too high), the 10-year really does not provide much completion for stocks at a 4% yield. Also, the 14.8 multiple on the the non-FAANGs+ is an average. There are stocks in the index that have languished and are much cheaper... a result of the bifurcated market we've experienced over the last few years. Large-cap growth was the only play for years. Everything else was trash. These numbers are worth your consideration:
A 4% coupon (the earnings yield) on a 10-year UST note is equivalent to a stock trading at 25 times earnings (earnings that will never grow).
(100 ÷ 4 = 25)
The current earnings yield on estimated 2023 earnings* for the S&P 500 sectors ex-FAANG+ is 6.76% on earnings that should grow somewhat over the next 10 years.
(100 ÷ 14.8 = 6.76%)
Even including FAANG+, the number is 6.2% - 50% greater than that of the T-note.
* FS Insight powered by Fundstrat
What this all suggests to me is that the constant fretting over what the Fed will do or say and the implications of continued strong employment numbers is noise. In the earlier portion of this post, we pointed out that Henry Kaufman kept a lot of investors at bay and out of the market during the run-up from 1975 to 1982. Remember, the S&P, at one point, was up 126% and never came close to its bear market low in the cyclical bear market Kaufman called the low on. This caution and negativity is proffered every day. Don't let them scare you out of your stocks.
What do you think?
P.S.: "The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated... " - Jerome Powell. Regardless of what Chairman Powell says, there is really nothing new here. The statement is consistent with the old news "higher for longer." Also, statements like this are intentional as ways of dampening inflationary expectations - telegraphing a message to consumers to "be careful." Hard times may be ahead. Finally, what the Fed does is data-dependent.
For further details see:
Another Trip To The Crossroads... We Are Not Holding Our Breath!