Coming off the tails of incredible gains in 2020 and 2021 the markets are hitting choppy water. Among the chief concerns for economists and investors is inflation, the rate of fed tapering, and the end of helicopter money. The question is what can we do to prepare for what is next and what is best positioned for the new narrative?
First let us look at some of the narratives steering the big money boats. These are the trillion-dollar money managers that control 90% or more of the S&P500, Nasdaq and DJIA. These titanics will do everything they can to avoid the next iceberg, so they have set their trading to de-risk. Everything with high multiples has become undesirable and labeled a Fed decision risk. Whether that is true does not really matter, because rising rates make high margin cashflows, positive earnings, and low debt to equity much more attractive than the companies that need debt to operate. The biggest gains of 2021 came from transformative technology in the computing, cyber security, and biomedical spaces. With the Feds actively sounding the rising rates horn, all the high debt companies will face decreased demand of ownership when there are other companies less reliant on borrowing to make payroll. That being said, the hottest 2021 growth stocks have seen a significant decrease (down 25-50%). The questions to ask are:
How much will rising rates hurt their cashflow?
At what point are they oversold?
And which companies will continue to grow despite the new economic environment?
The federal reserve crosswinds are pushing the biggest ships toward warm and safe cashflows, but earnings are right around the corner, and they may be tempted to leave their value stocks for the growth that proves rate resistant.
Looking at 2022, investment markets will continue to walk like a two headed duck. The one head looking out for inflation and rate hikes, the other head looking for performance and growth. The fed’s rather sudden acceptance of inflation and “commitment” (we’ll see) to fight it will help to shake out the companies that cannot sustain their debt load. The loudest narratives will drive market performance back and forth between rate resistant (high cash flows, low debt) and inflation resistant (commodities and high earnings growth) companies. Expect the duck to turn when rate hikes command the focus and to turn back shortly after the hikes occur. Market experts say the Fed can only do between two and seven rate hikes this year with anywhere between 15bps hikes to 50bps hikes. You can distinguish the investment managers from the bankers by these numbers, obviously investors want less rate hikes while bankers profit from more rate hikes… One thing is clear though, the fed feels responsible for fighting inflation and they will do it with hiking rates and tightening the money supply.
Speaking of money supply, Nobel Prize winner Milton Friedman points out, “The government solution to a problem is usually as bad as the problem.” Friedman’s quote feels specifically timely looking at the past two years, and I wonder moving forward if this feeling changes? At the start of 2020, the global pandemic closed businesses, shut down traveling, disrupted the supply chain, and continues to do so. The governments responded with forgivable loans to keep employment as high as possible, economic stimulus payments, raising unemployment benefits, and federal reserve QE. All this resulted in people spending money, then they refinanced their mortgage to save money then they bought that new car for zero down and 0% financing, because why not? Then they went to their boss and said, “hey I’m getting offers for double my salary, what do you have for me?” and they took that new job or went on unemployment, bought their Christmas presents early and then bought more because their new employer came through with a bonus funded by the Paycheck Protection Program loans and now we sit in January looking at the largest percentage jump in M2 money supply in US history and the greatest inflation since 1981. We walked into 2022 with demands for minimum wage increases, a reluctance to re-enter the workforce, and the greatest expected employee retirement numbers on record. So, what does all this mean for investment portfolios? It means December 1st, 2021, was a great time to sell and January 2022 is a great time to sift through your portfolio and look to own the companies that wisely allocated their low interest debt toward growing business segments instead of employee wallets.
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