the Fed news conference last week

The Fed held its usual post-FOMC meeting news conference last Wednesday. The main points, as I see them, were that:

–the economy is at least as good as expected,

–inflation is stronger than expected, therefore

–the Fed is going to move more quickly than previously thought to raise short-term rates and to shut down its bond-buying program

–the number, size and frequency of rate rises will depend on how effective the first few rate rises are.

my thoughts

What was news, other than the Fed understands the current economic situation and has lost its previous reluctance to act (for fear of slowing economic activity too much)? Who didn’t know this already?

The bond market was fine with this (yields rose a few basis points and gave most of that back the next day). So, too, were currencies and commodities. But stocks, which had been falling all month, dropped sharply, although they, too, are starting to gain back these losses. The thing I noticed is that the financial press was immediate, and very sharp, in its criticism of the Fed. I’m interpreting the stock drop as the effect of AI reading overblown press accounts and selling on them. Why not the same reaction in other markets? I don’t know, but my guess is that the other markets are harder for short-term speculators to move, either because they’re bigger or more under the control of big international banks.

On the other hand, it’s never one-and-done with important news being discounted in the market. Investors replay the same ideas multiple times until one day the “news” ceases to have any effect. For a head-scratching optimist like myself, last week means we’re another step closer to having rising interest rates baked into prices.

The end game for the Fed: it’s to return to non-emergency conditions by establishing positive real yields for fixed income instruments. If there’s any news from last week it’s that the Fed may have decided that, as some commentators have been suggesting for a while, that the trend rate of inflation that’s now acceptable for the Fed is 2.5% – 3.0%. That would imply eventual (meaning a year or so in the future) 10-year Treasuries at a yield of 3.5% – 4.0%. That suggests a PE for stocks on earnings of 25x – 28x in 2023. The S&P 500 is now trading on about 20x 2022 estimated earnings and on 22x 2023 earnings. This suggests there’s still upside from here, whatever day-to-day volatility there may be.

One other thing–bonds yielding something like 4% would seem to me to provide an attractive alternative to stocks for income-oriented investors for the first time in years. Arguably, this would suggest a slightly lower PE on stocks. We’ll see.

Microsoft (MSFT) and Robinhood (HOOD)

This is about the two stocks, MSFT and HOOD, but I think they’re also illustrations of how today’s US stock market functions.

MSFT; the other day the company reported earnings after the close. From the data in its press release, it was clear that MSFT’s cloud offering, Azure, hadn’t shown much grown during the quarter.

The stock dropped immediately, either because of the result itself or because market expectations were considerably higher (my guess is the former).

On the ensuing conference call, MSFT management explained that Azure continues to grow strongly, but that the business is lumpy. That is, it consists of very large deals–something any analyst is surely aware of–and that MSFT doesn’t use recordkeeping tricks to make this less obvious in the financials–again, something any analyst would know. Anyway, contracts that might easily have been signed in December were signed in January instead.

The red stock quote immediately turned green.

For good or ill, this is today’s world: AI reacting fast, but in a relatively unsophisticated way, to the latest public newsfeeds.

HOOD: my take has been that the company made a brilliant choice in naming itself but acts much more like King John or the Sheriff of Nottingham than Robin of Locksley. Perhaps because of this apparent indifference to customer wellbeing, the stock has been a real clunker. Yes, it came out at $38 in early August and raced ahead to $85 the following day …but it is just under $11 as I’m writing this today.

I find two things interesting about HOOD now.

–it has a brand name, it has a large share of the underserved market of younger investors and it has about $8 a share in working capital. In other words, it’s a prototypical value stock

–I turned on CNBC while I was having lunch yesterday. What I saw/heard was a male moderator (who’s a good proxy for dumb money) explaining to a female panelist (a professional investor) that ARKK-like stocks will never recover.

yesterday was an important day for stocks, I think

It may not have been the most important day, but it was significant to me, nonetheless.

During the first hour of trading, with no obvious trigger, the major stock indices dropped by about 5%. For the fading techy stars of 2020-21, the negative numbers were more like -10%. Just as suddenly, the market reversed itself. Positive momentum was the greatest for the first-hour’s biggest losers, which by and large finished up on the day.

Why is this movement potentially important?

In every down market (we’ve been in one for what one might call Cathie Wood stocks for about a year), investors of all stripes tend to hold onto their former winners despite mounting losses. At some point, the red ink becomes too difficult psychologically for even professional investors to bear. Even though holders’ brains may be telling them it’s the wrong thing to do, they give in to their fears–and to their customers’ calls for change–and dump out their underperforming stocks without regard to price.

This angst-driven selling capitulation invariably marks the bottom of the market. It frees capital to be redeployed away from losing stocks. More important, it serves as a market signal that the worst of the decline is over.

The worst of these that I can recall came in 1987. To put the story in much too simple terms, during that summer, 30-year Treasury yields (the benchmark back then) rose to 10%. The PE on the stock market at that time was 20x, indicating a severe overvaluation of equities relative to fixed income. (There were also federal deficit and currency problems, but I’m ignoring them. The link in the next sentence has a fuller account.) On what came to be known as Black Monday October 19th, much of this imbalance was rectified through a one-day drop of 20%+ in stocks. Stocks also closed at the lows, another apparently bad sign.

Although things looked pretty grim overnight (one of my portfolio colleagues had a nervous collapse on the subway on the way home, had to be hospitalized and never managed money again), the Monday lows held.

I have no idea why, other than that it happens, the market always seems to bounce and then come back to “test” the lows several weeks later. If the market reversed course at or slightly below the prior lows, this is taken as evidence that forced selling is over and the previous downtrend is no longer something to worry about.

Three aspects of today’s situation:

–yesterday’s decline, while a little scary, was relatively modest. My guess is that we continue to trade with yesterday’s worst levels in the market’s mind until we get more evidence that this is indeed a low

–bond and stock valuations are nowhere near as out of whack as they were in 1987

–if we look at overall market action over the past year, there’s little sign of trouble. Yes, stocks have been declining since last November, but the overall drop has been modest. True, but look at the stay-at-home stocks or the Cathie Wood universe. There the story is very different. At yesterday’s lows, ARKK, Wood’s flagship fund, had dropped by 58% from it’s February 2021 high. This is a whale of a bear market, and it’s been going on for almost a year. HOOD has gone from a high of $55 to $11, for example, ZM from $479 to $149, PTON from $150 to $24.

more tomorrow

from weak hands to strong hands

It took me a while to come up with a description I’m satisfied with to write about what I think is going on in the current stock market.

Three major impediments/distractions for me:

–in the old days, when, as they say, men were men and giants roamed the earth (notice, I didn’t say the good old days), what drove the stock market was the four-year election cycle. We’d have 2 1/2 years of up, and a presidential election followed by 1 1/2 years of down. Sometimes it was 3 years of up, 1 of down. The sitting president would arm-twist the Fed into lowering rates in the runup to the election, putting the economy into temporary overdrive, and then clean up the mess this made in the new administration.

We really haven’t had the kind of ugly market we’re now in since 2008, though, so we’re all out of practice with the idea that stocks can go down as well as up.

–the selling seems to me to be heavy-handed. By that I mean downward pressure is not thrust/counterthrust but a relatively unsubtle straight down. My guess is that the major players are computers, but that’s a secondary thought. The result has been, I think, that potential buyers no longer anticipate intra-day counter-trend rallies, so they’ve more or less left the field to the selling robots. They in turn have doubtless been trained to push prices aggressively lower until they hit buying resistance. As a result, even a whiff of selling can cause a significant price drop.

I think this makes stocks fall faster and farther than they otherwise would. But this is the world we live in today. I imagine this implies an explosive rally at some point. Since I have no clue when this might be, it’s cold comfort.

–press commentary is unusually inane. I read a Bloomberg article earlier today, for example, that implicitly compared today’s situation with Wall Street in 1929 and Tokyo in 1989–both events that marked the onset of decade-long+ economic contractions.

the hands thing

I don’t think this selloff is about macroeconomics or about global or national politics. If the 10-year Treasury is going to be at 3% a year from now, or even six months from now, the PE on stocks should be around 33x. Today’s PE is about 25x.

But prices don’t just reflect the more-or-less objective characteristics of companies an economies. They also reflect the hopes and fears of the investors who hold them.

One way of sorting investors: a group that has extensive knowledge of the companies whose stocks they hold and their prospects. They’ve read the SEC filings and the financial press, and may even have made detailed spreadsheets projecting future earnings. These are strong hands. Then there are owners who have bought the stock on a whim, or because of a tip from a friend or a tv commentator (probably without Googling the the talking head to get a bio). Anyway, these are weak hands.

I think that the current extended selloff in the market is essentially a psychology-driven movement of stocks from weak hands into strong. Fear overcomes greed and low-conviction holders, seeing losses, elect to sell rather than risk further declines. Often, this ends in a selling climax, a sharp decline on high volume during which weak hands sell their remaining stock. We may be nearing this point now, but I find I’m not yet thinking about hiding under the table, so a climax may be a ways off (unfortunately).

Microsoft (MSFT) acquiring Activision-Blizzard (ATVI)

MSFT and ATVI announced this morning that ATVI has agreed to be acquired by MSFT for $95 a share in cash, a total of $68.7 billion (ATVI has about $6.5 billion in net cash, so MSFT’s outlay will be just over $60 billion).

My general reactions:

–MSFT has a market cap of about $2.4 trillion, had $130 billion in cash on its balance sheet at 9/30/21, and is generating cash at about an $80 billion yearly rate. So ATVI is kind of a drop in the bucket

–MSFT says ATVI will be key in developing its metaverse platforms; ATVI had lost about a third of its market value since mid-2021 as details began to surface of a toxically anti-woman work environment at ATVI that management appeared ill-equipped to handle

–a week ago Take-Two Interactive announced it will acquire phone-game maker Zynga for $12.7 billion(about two-thirds in stock, one third in cash). The similarity between the two deals, to my mind, is that Zynga had lost half its market value over the past year

What really jumps out:

–my guess is that ATVI’s board thinks that MSFT bails it out of a very messy situation that it had little chance of fixing. If so, MSFT had the upper hand in setting terms. I find it interesting that MSFT chose to pay cash rather than issuing stock–implying it thinks is shares are still undervalued

–these deals could be an early sign that corporate America thinks that the selloff in tech-ish stocks, which , after all, has been going on for about a year, has gone far enough to establish substantial value in potential targets and that there’s no reason to bet they’ll go much lower. This doesn’t mean that we’ve reached absolute bottom–or even that the acquirers are correct in their assessment (although I believe they are). But it’s an encouraging sign.