DOCU - The Harder They Fall The Higher They Bounce Whither Interest Rates

2023-12-11 00:26:38 ET

Summary

• In this article, I discuss the current state of interest rates and their impact on the stock market.
• I predict that the Federal Reserve will not cut rates and warns of potential volatility in the market.
• I share my investment strategy, including potential buys in companies like MongoDB, Nvidia, and DocuSign.

I don’t claim to be an expert on interest rates

However, I and the rest of you have lived through quite a volatile time for interest rate levels. We got to see the 10-year reach for 5% and now not too much time later and in the present we can imagine the 10-year breaking below 4%, Right now the sensitivity is to higher rates, not lower. At this point, the weaker rates bring more purchases of equities. The rally is now spreading from profitable large-cap stocks with piles of cash back to “long-duration” equities. Long-duration equities are stocks that are expected to produce their highest cash flows in the future. These companies are often growth-oriented and are more sensitive to interest rate hikes and inflation than their shorter-duration counterparts. That’s because the higher interest rates rise the less valuable will be the future stream of earrings from these companies. The reason this is important, exciting even, is that growth stocks in diverse fields biotech, cloud software, tech adjacent finance companies, MedTech, and even regional banks rebound and in my mind attain the proper valuation. At this point, you are probably thinking that the bounce I am referring to is regarding equities. Well, that is understandable, I have been calling for a rally into year-end as this is traditionally the best part of the year for stock. Perhaps these good times continue into January and perhaps even most of February, or they end sooner. I wrote about this last Sunday I am not backing away from that prediction at all.

Prepare for next week, which could hold surprises

I just want to get more granular with you, so that you can mentally prepare for next week. We are all practically bored with the Fed and the FOMC meeting. What will Powell say that he hasn’t said already regarding rates? No one believes that he is holding another rate hike in reserve. Not with the truly benign numbers this past Friday regarding employment. Forget the job creation and the falling unemployment percentage of 3.7%, right now. The real numbers to elevate are productivity up sharply at +5.2%, and, that unit labor costs down 1.2%. Jolts has moderated further, something Powell has been tracking, open jobs to available workers is the lowest since March of 2021. This means that the demand for workers is moving lower. Not to the point of job loss, but not pressuring worker’s pay ever higher either. The worker participation rate, a number I pay close attention to rose albeit slightly. In November 2023, the labor force participation rate in the United States was 62.8%. an increase from the previous month's rate of 62.7%. As long as it continues to march upward the health of the US economy continues to strengthen. So just to finish setting the table, equity investors have every reason not only to ignore the FOMC meeting on Wednesday, and Powell’s pronouncements, but also the CPI, and PPI. These latter two inflation indicators are not even his favorites being the “Super-Core” PCE that focuses on services inflation. Even so, I want to take this moment and caution you. Or to put it in a more positive light make you aware of the possibility that when the stock market doesn’t get exactly what it wants it could sell off and create a buying opportunity. Namely a sudden jump, albeit temporary in the 2-year and 10-year bonds

Predictions are hard, especially about the future - Yogi Berra

I can state with certainty just from interacting with my Group Mind Investing community, that the expectation of higher stock prices is being taken for granted at this point. It’s not just them, according to CNBC, retail investors poured $6.8B into equities, the highest since March ‘22. Most of the flows went into individual stocks. No one wants to hear, that a rate cut is not coming in March. I fully expect Powell to state strongly that he sees no reason to cut. The truth is, from my point of view, the economy doesn't need lower rates right now. Oil is about to break under 70 per barrel, Nat Gas is back below 3 bucks, and food costs are coming down. Yes, the cost of protein is still much higher than it was, and plenty of grocery items are way high, but they are coming down.

Here’s a 1-year chart of wheat courtesy of CNBC

You feed Cattle, Chicken, and Pork with grain in feed lots to fatten them up before they find their way into your grocery freezer. Here is a 1-Year Live Cattle Chart courtesy of Seeking Alpha

Ok, so food costs are coming down. Not as fast as we like and not as consistently, but they just are. Am I not, arguing against my point, why not lower rates if inflation has been beaten? I hate to use the goldy locks analogy but nothing is broken, so why fix it? In other words, what if the current level of rates is exactly where it needs to be right now?

We still have huge government spending and piles of new debt going out to the credit markets, this could reignite inflation, if we aren’t vigilant. So that brings me right back in my usual roundabout fashion of what could happen this week. For one Powell will wag his finger and exclaim “No rate cuts for you”, this was said many times before. What if we get a higher CPI number on Tuesday, and then a bad PPI number on Wednesday? We could have a surprisingly choppy week this week. Rates could jump, and panic equity holders to sell.

This is not a warning to sell, it is a caution on when to buy

So after all this, what I am getting at is, if we do have a little disappointment on the inflation statistics, and Powell once again makes it clear that rates are not coming, which I support, then the buying opportunity is at the end of the week not at the beginning. I think the market is so inured to Powell at this point that you will have a few days to trim up some positions and have a slug of cash waiting to deploy in some juicy trades. If you are a long-only investor, and you have some funds to deploy, unless you must invest before year-end then fine now is as good a time as any. However, if you have the flexibility, I would wait until the ides of March, as Shakespeare the equity expert would I am sure agree, I think we should see cheaper stocks.

Just in case I didn’t make this abundantly clear last week

Stock market participants are thrilled with lower interest rates on the 10-year and lower prices right now. As we all have experienced in life, too much of a good thing is never all that good. As long as interest rates remain volatile either sharply stronger rates or much weaker rates will hurt stocks. At some point, lower rates and prices could embolden the bears. This is another reason why I don’t want Powell to lower the FFR right now. If a recession hits he will need the firepower. If it is just stagflation hysteria pushing rates lower it will only heighten the fears and create an issue that isn’t there. Powell must keep a steady hand.

So in summary; I am still very bullish about the year-end and the start of the new one. I just want you to prepare for what could be a bit of a jostle of interest rates in the first half of the week and that one should set aside cash for, and then go shopping Thursday and Friday.

So what am I buying?

This is unusual for me but I am trying to get long MongoDB (MDB), I almost got in via call options but I missed my price and I was unwilling to raise my bid. Like I said, I may have a better shot later this week. I feel the same way about Nvidia (NVDA), I think it could falter a bit more and give me an entry point of 430, but I will keep a tight leash on it. We have seen NVDA touch 400, and I want to wait until the end of the week to see if there will be selling pressure. I much prefer the cloud tech and services space names like DocuSign (DOCU), I added some shares when it sold off in the premarket after their earnings report the night before. I would love to buy more at that 44 level again. They are diversifying their offerings building on top of their signature service, and calling it their agreement cloud service. This is a great area to exploit, the management of the interaction in building an agreement, I think covers a large unmet need. I also think monday.com ( MNDY ) is coming into an interesting price level. Right now I am just in DOCU. I did manage to trade Meta Platforms ( META ) this week. I got long on the call option at the 315 strike, out to March. META climbed quite nicely so I closed out half my Call contracts then rolled up the rest to the 325 strike. I will ride it as close to their 52WH as I dare, but I am a bit of a chicken. I am also long Amazon ( AMZN ) and Microsoft ( MSFT ) but I got shaken out of my Alphabet ( GOOGL ) trade. In the end, I might have made the correct move since their new Gemini has purportedly included some editing in that demo that wowed everyone. I won’t say I saw that coming but I will say, I was watching the price action and it seemed like GOOGL was not going to hold that 130 level. Why am I trading options and not equity? I am trying to leave aside as much cash as possible so I can be net short going into mid-Q1. Right now, I am only short on Arm Holdings ( ARM ) via Puts. I think it is ridiculously expensive on a P/E basis, the business model is flawed, as there are open-source (as in free) RiSC chip libraries out there. On top of that SoftBank is still owning a big chunk of shares and they will be selling those shares to show some success.

Remember Cash is your friend this week. Happy trading!

For further details see: