Stocks closed mixed to slightly lower as growth stocks gave up ground on rising bond yields. Stocks struggle to find direction ahead of this week’s inflation figures and the start to Q1 earnings season.
Cash is trash! Rightly so, we have been heavily focused on the real impacts of inflation over these past several months. For many years inflation was just something that existed in the fantasies of politicians and economists. For us consumers on the ground, price growth remained fairly docile for decades. Sure, prices of goods have gone up, but only mildly and with occasional short-lived spikes. Well, inflation is here now, and there is no disguising it. We are feeling it, and even Fed bankers, usually staid and dry, are getting a bit emotive about it. The Fed, at this point, has no choice but to attack inflation head-on, and as inflation continues to rise, so does the Fed’s saber rattling and battle preparation. Just as the central bank dug deep into its playbook to stimulate the economy at the start of the pandemic, the Fed is now digging deeply once again, but this time it is attempting the opposite: to slow the economy down and tamp down inflation. Sure, rate hikes are coming, bigger than normal ones seem likely as the Fed plays catch-up. Now markets are contending with a whole new set of screw-tightening maneuvers which include the Fed’s aggressive selling of Treasury and mortgage-backed securities. I say “aggressive” because compared to the similar quantitative tightening of 2017 this next one will be noticeably larger in size. Back in 2017, the largely procedural move began with monthly sales caps of around $10 billion and ultimately rose to around $50 billion. Based on last week’s comments by Fed Governor Lael Brainard, which were confirmed in last week’s minutes release, the Fed is contemplating a monthly balance sheet runoff of $95 billion per month, to start as soon as May. Ok, in anticipation, bonds are trading lower, and yields are rising, doing the Fed’s work for it. Those rising yields are causing borrowing costs to go up for consumers and businesses alike. The goal is to cause us to temper our spending to allow inflation to recede. Those rising bond yields have been significantly holding back any rallies in growth stocks, whose prices are theoretically impacted by the moves. Future cash flows, the hallmark of growth stocks, are discounted by yields into present values, which go down as yields go up. Theoretical, yes, but despite it, markets have been held back as a result. So, it is therefore, safe to say that our investments are indirectly, negatively impacted by inflation.
Wait a minute, before you get on with your day, I have one more important point to share with you. Inflation also has a direct impact on your investments as well. We all throw around bond yields, coupons, and equity growth rates. “My stocks grew by this, or my bonds yield that,” we say frequently, and when we do that, we are most often quoting a nominal rate. That nominal rate does not factor in the rate of inflation. Why is that important? Well, if you place your hard-earned savings in an investment to grow and it gains +2%, you might be satisfied that you will have 2% more savings to spend after letting it grow for the year…unless the prices of nearly everything you want to buy cost +7.9% more than it did when you began your investment. In this example your investment, even after growing by +2%, will buy -5.9% less stuff than a year ago. This is referred to as the real rate of return, which factors in inflation. Real, indeed! It is no secret that Treasury bonds have experienced very low yields since the early aughts, just barely earning more than the low rate of inflation we experienced. Stocks, on the other hand, earned considerably more than inflation in the past several years making them a very worthwhile investment. Just in the past 12 months or so we have witnessed headline inflation ramp up from a mild +2% to almost +8%. At this point, no matter what maturity you pick, there is no spot on the Treasury yield curve where you can earn a positive real return. While stocks certainly have the potential to clear that hurdle on average, it is still getting too close for most investors’ comfort. This, along with a whole array of events, both globally and locally, are affecting performances of stocks, which is perfectly understandable. The volatility and uncertainty in markets has caused many investors to sell and stick to cash, waiting for the growth challenges to abate. Unfortunately, there is a problem with that. The value of your cash also loses value in an inflationary environment. Remember our example from above? If instead of investing in that 2% investment, you decided to hold cash in order TO BE SAFE, your savings would be worth less by the full +7.9% inflation!
These markets can certainly evoke a bit of emotion. We are dealing with new forms of geopolitical risk, inflation at a 40-year high, and a catching-up, hawkish Fed. Did I mention that stocks are at above average valuations…and that the PANDEMIC IS NOT OVER YET, posing new potential risks every day? I probably didn’t have to mention it, but I am sure that many folks are considering sticking to cash until things calm down a bit. While that is certainly a smart plan for those investors who need access to liquid cash in the short run, but for those who are seeking long term capital growth, sitting on the sidelines with cash exposes your savings to the value erosion of inflation. Indeed, risky investments can lose considerable value in volatile markets, but there are still many available investments with lower risks and defined maturities in which you will receive your principal back (credit risk aside). Treasuries maturing in a year now yield around 1.76%. That doesn’t seem like much, especially with inflation around 8%, but a real yield -6.24% is better than your cash being worth -8% less in a year. Cash may seem safe in these uncertain times, but you have to remember that cash in these times, or any other is always a losing investment…when inflation is factored in.
WHAT’S SHAKIN’
Twitter Inc (TWTR) shares are slightly lower in the pre-market after the company had announced that Elon Musk would not be joining its board after a week of speculation following a sizable investment made by the billionaire. Shares are currently lower by -1.06% after erasing more sizable gains earlier this morning. Potential average analyst price target upside: -3.9%. WHY IS THIS NEGATIVE? Because the company’s share price is higher than the average analyst price target. While this may be interpreted as a stock being expensive or overvalued, it does not mean that a stock will not continue to climb.
Tesla Inc (TSLA) shares are lower by -3.90% in the pre-market after it was learned that the company’s car sales in China fell by some -10 in March as a COVID-19 spike gripped the company. An announcement that Tesla founder Elon Musk will not join the board of Twitter may also serve to put pressure on the stock, even though both companies are unrelated. -7.0%. WHY IS THIS NEGATIVE? Because the company’s share price is higher than the average analyst price target. While this may be interpreted as a stock being expensive or overvalued, it does not mean that a stock will not continue to climb.
FRIDAY’S MARKETS
Stocks closed lower on Friday as spiking bond yields pressure caused selling. The S&P500 slipped by -0.27%, the Dow Jones Industrial Average gained +0.40%, the Nasdaq Composite Index fell by -1.34%, the Russell 2000 Index gave up -0.76%, and the S&P500 ESG Index declined by -0.34%. Bonds fell and 10-year Treasury Note yields climbed by +5 basis points to 2.7%. Cryptos fell by -1.09% and Bitcoin declined by -1.75%.
NXT UP