Tug of War
There's a huge tug of war going on in the market. Yesterday the market was signaling that the economy is ready to take off after suffering one of the deepest recessions in a decade to the market selling off today due to the continued spike in interest rates (10-year Treasury) which COULD mean big ugly inflation might kill this recovery. So far there isn't much inflation (10 million people are still unemployed!) but the 10 year is really worried about it and so people sell risky assets like stocks. One of the biggest clichés in the market is: “Stocks take an escalator up, and an elevator down”.
So the question is why is big tech getting crushed because of higher interest rates? Instead of applying the traditional valuation method of EPS x P/E multiple to judge if the stock is cheap or expensive relative to its growth, the market has instead applied the discounted cash flow method to valuing big tech due to the long-dated value of these companies. When you discount cash flows, if the discount factor is high, the present value is low. If the discount rate is low, like close to 0%, then the value is extremely high. If you divide a number by 0, it has no meaning... OMG my head just exploded!
So when the market sells off its important to remind everyone of a few key factors and not to get stressed out about short term market volatility:
1. Accommodated Fed. Given the Fed’s stated intention to keep rates lower for longer, it is hard to think that they would not intervene should rates move quickly toward the 2% level for the 10-year note.
2. Stimulus. The economic backdrop is improving amid high odds of further stimulus. When folks get their checks - they will either 1. Invest in the stock market a la GameStop, 2. Spend it on stuff, which is good for earnings or 3. Save it which doesn't cause inflation. All three things are positive from a market perspective.
3. Copper is the new Gold. My favorite indicator for gauging expectations of global growth is not flashing a warning. The copper to gold ratio is actually accelerating to the upside in a move that coincides with a rising 10-year yield (things are getting better).