Yesterday afternoon, the Fed said the recovery was far enough along that it can start “tapering” before the end of 2021. The stock market dropped sharply on this news before recovering before yesterday’s close (btw, typical market behavior on almost any Fed news).

What does this mean?

The primary money policy tool the Fed uses is the Fed Funds rate, which it sets, and which is the rate banks use to lend and borrow money overnight. This is the shortest of short-term rates. In most circumstances, changes in the Fed Funds rate ripple quickly through longer maturities–like the Treasury market and the rates on loans banks charge their corporate customers. But during the 2008-09 financial crisis, longer-term rates stayed stubbornly unmoved by anything the Fed did with the Fed Funds rate. So the Fed resorted to “unconventional” measures. It started to buy lots of longer-dated Treasuries for itself. The relative scarcity this creates pushes Treasury yields down, because other buyers, like banks and investment companies, have to offer better terms (i.e., accept lower rates) to make a purchase than they would if they were the only ones bidding for the securities.

Yesterday, the Fed said it would begin to “taper” (reduce) the mammoth level of Treasury purchases it has been making regularly during the pandemic. When Ben Bernanke said something similar in May 2013, his statement provoked a “Taper Tantrum” of higher rates in the bond market. This time, not so much, at least so far. My guess is that’s because this is the second time we’re seeing this situation and have some past experience to rely on.

What does this mean?

For some time I think we’ve been in an inbetween conceptual space. We knew in a vague way that, at some point, the period of near-zero interest rates would be over. But because we had no firm evidence about when, the markets had no reason to react in more than in a vague iffy way.

Now the situation has changed. We don’t have the certainty that we will when tapering actually begins (December?). But the market background of near-infinite monetary accommodation (and near-zero rates), which allows firms with even so-so earnings prospects to trade well, is fading away. In its place, we’re moving into one of rising interest rates. Yes, by historical standards they’ll remain low: my idea is that the 10-year Treasury will ultimately settle in at about 3%; the consensus, as I see it, is 2.5%. But relatively strong earnings growth, and especially near-term growth, will be the principal (only?) defense against the market PE contraction that higher rates will induce.

A second, less adequate, I think, defense is what I think of as “you can’t fall off the floor” stocks. Ones that may have limited prospects but which are already trading as if they’re road kill. Macy’s (M), up by 22% today, is indicative of the type. This may be another way of saying that traditional value stocks will enjoy one of their increasingly rare days in the sun.

So we’re entering a new phase of the stock market, where valuation and conviction in the solidity of earnings growth in 2022-23 will be increasingly important considerations. Pure story stocks will do less well. PEs will count for more, although bonds at 3% imply stocks will still be selling at 33x earnings.

One complicating factor: the false Trump COVID-is-a-hoax narrative, still professed by acolytes Abbott, DeSantis et al, which continues to prolong the pandemic–and retard economic recovery in areas like travel, entertainment and dining…. We can already see this reflected in the collapse of the related stocks over the past month or two. It’s unclear, to me anyway, given the obstinacy of pandemic denial, whether weakness will be confined to the directly affected stocks or will spread wider.

Plain-vanilla corporations in the US have their income taxed by the government in the year when the profits are recognized. If the company distributes part of those profits to shareholders as a dividend, the dividend is seen by the IRS as income for shareholders and, despite having been taxed once, is taxed again.

Mutual funds and ETFs are a special type of corporation. Their profits are not regarded as taxable income at the corporate level, and are only taxed on distribution, as shareholder income. In return for this exemption from corporate tax, mutual funds and ETFs must have a narrowly focused business purpose and must distribute virtually all their yearly income to shareholders.

Mutual funds and ETFs, however, can be very different from one another as far as distributions go, in a way that I didn’t understand at first and which can be important for us as shareholders. It has to do with how redemptions are handled.

Let’s take an ETF and a mutual fund and assume:

–each has large unrealized profits from investments made years ago (think: MSFT bought in 2014 and up by 9x since) and no cash on hand.

A traditional mutual fund has $10 million in redemptions from a long-time shareholder. It sells MSFT to get the money needed, realizing a $9 million capital gain doing so. At the end of the fiscal year, normally in October, the mutual fund distributes to each shareholder at that time their proportionate share of the MSFT gain that they must pay income tax on. It isn’t the selling shareholder who pays, even though he has most likely benefitted substantially from the 9x gain on MSFT. It’s the holder of the mutual fund shares at the time of the distribution, even if he has only bought the mutual fund shares on October 30th, who is responsible for paying the tax.

An ETF, on the other hand, does not deal directly with its shareholders. Instead, the ETF designates a small group of market-makers, typically large brokerage houses, as intermediaries to handle buying and selling. In particular, in the case of redemptions, the intermediary can present shares for redemption to the ETF and receive stock held by the ETF in exchange, instead of cash. The details of how much and how this is done are spelled out in the contract between the ETF and the intermediary. To the extent the ETF delivers stock, it it is not selling, and therefore not realizing capital gains.

This characteristic of STFs is a big reason, I think, that mutual fund complexes are beginning to convert their actively-managed offerings into ETFs. A second is that something like half the fees charged by mutual funds go to support the in-house agency that handles buy and sell orders and keeps the fund’s records. I don’t know how that compares with the bid-asked spread that ETF intermediaries maintain, but that’s invisible to shareholders while the mutual fund administrative expenses aren’t.

Yesterday I wrote that I’d stopped looking at my portfolio for a while early in the year. That’s not exactly right. What I should have said is that I stopped tinkering with my portfolio, making minor adjustments aimed at improving the chance for a market-beating return.

So I was looking every day at how my stocks were performing. But I’d reached the point where I thought I had done all the productive stuff I was going to and that any further changes would be one of two things. They’d either be busywork, change for the sake of change, or I’d do something stupid. Said a different way, I’d take what the market would give me because the portfolio I had was the best I could do.

In the same vein, one of my first bosses, who taught me a lot about how to be a competent portfolio manager, had a favorite saying: “Don’t chase.” That is to day, don’t buy a stock that has already gone up a lot. Instead, look for a stock with the same characteristics, or in the same industry, that hasn’t moved yet. Or spend your time trying to figure out the next thematic move for the market and orient your portfolio to catch the next big wave of performance rather than jockeying for the last 10% (which may or may not come) of the current wave that may be close to cresting.

As with everything in the stock market, maybe in life in general, as well, there are caveats to this advice. I have a friend whose basic strategy is to chase. She trades a lot, as a result, giving her taxable clients a hefty IRS bill and herself an arguably unnecessary ton of work, but she’s exceptionally good at it.

Sometimes, too, the wave doesn’t crest for years and what you think is a short-term trading rally is instead a fundamental shift in the market direction. In this case, however, there’s probably some very basic economic factor you’ve missed.

“Sell in May…” is a British slogan that has its roots in the old-time composition of equity markets in the US and Europe–meaning no tech and lots of heavy industry–and the European labor practice of shutting factories down and having everyone go on vacation in August.

Yes, most European exchanges are still tech-deficient and in a normal year Europe shuts down for the month of August. And, yes, in a normal year Wall Street bigwigs decamp for the Hamptons in the summer, leaving behind assistants with limited power to act on their own and an aversion to disturbing the boss’s wa. So, yes, in a normal year there tends to be lower volume and less price volatility in world stock markets than in other seasons. But this is not the big thing it once was, particularly so in the US. Here, almost half the market is tech and very little is heavy industry or energy (where the summer driving season is a big thing).

Having said all this, there has been a notable change in the direction of the overall stock market since about the beginning of June. I noticed this mostly because I realized that after a startlingly good 2020 and the inevitable giveback earlier in the year, my portfolio has, contrary to my expectations, somehow gone from, say, ten percentage points below the S&P in March (I stopped looking for a while, so I don’t know precisely what the nadir was) to -2.5 percent now.

How did this happen?

Since June 1, the major indices have performed as follows:

Nasdaq +8.1%

S&P 500 +5.4%

Russell 2000 -2.7%

Year to date, the results are:

S&P 500 +18.1%

NASDAQ +15.0%

Russell 2000 +13.0%.

To me, the index results say that since June the market has shifted away from prizing stocks that will benefit from broad-based cyclical recovery, returning instead to secular growth names. What the indices don’t say, but what I think is the case, is that at the same time there has been a sorting out of stocks in the secular category between those whose allure is mostly a function of the pandemic and those whose prospects are on sounder footing as the pandemic abates.

I don’t think the relative strength of NASDAQ is just a summer thing that will disappear on Labor Day.

I read the R2000 weakness as a result of worries about the delta COVID variant and the large number of unvaccinated Americans. I have hopes, but nothing I’d care to bet on, about how that will play out. So I’m no longer as eager to have smaller-cap US exposure as I was after Trump’s defeat (last month I sold the tail-end of the R2000 position I built up after the election last year).

Last week HOOD sold 55 million shares in a failed IPO, “failed” meaning the stock ended the day below the $38 offering price.

Wednesday, trading in HOOD stock options began. The stock came close to doubling, closing at $70.39, as meme players piled in.

Yesterday, private market holders of HOOD who had not participating in the Monday offering declared their intention to sell close to100 million shares. HOOD fell by 28% on this news, closing at $50.97. Volume was 82 million shares, which is only a small number when compared with the prior day’s 176 million. Given that the float is 55 million, every share changed hands more than three times on Wednesday.

HOOD is up by 11% in pre-market trading as I’m writing this.

What I find most interesting about this is the decisions of the institutions who announced yesterday. They were not interested in selling at $38. Whether that’s because they thought the price was too low or they didn’t want to depress the offering price–and therefore lessen the cash HOOD would receive to help expand/improve the company–isn’t clear.

It could also be they were anticipating what happened once options trading began and were waiting for the stock spike to sell. One argument that they were is that once the meme traders began to work their price magic they showed no hesitation in heading for the door.

Again, it’s unclear whether these institutions, who arguably know HOOD better than anyone else, are selling with the intention of buying back at lower prices once the meme-ers have run out of steam or are making a permanent exit. At the very least, however, they have already staked out territory market “too high” for savvy fundamentals-based investors. It will be interesting to see how much this means to meme-ers (my guess is not much).

I’ve got no interest in owning HOOD. But I think this situation will likely serve as a template for future HOOD-like IPOs. So it’s worth paying attention to learn how future such IPOs will play out. My suspicion is that this will become the norm so long as interest rates remain near zero.