Growth stocks thrive on low rates, but with the Fed in focus and bond yields climbing, investors need to stay sharp. Here's what it means for the rest of 2024 and for 2025.
What the hell am I doing here? I don’t belong here. Or do I? Belong here, that is. Supersized tech stocks touched the sky yesterday reaching new highs yet again. That helped propel the Nasdaq to fresh highs and the S&P500 within striking distance of its all-time high. The challenge is that it is a few special stocks that are doing all the heavy lifting, and that lack of breadth has gotten a lot of folks a bit concerned.
Whether it is merely perception or there is some yet-undiscovered math equation, market watchers believe that a quick rise with narrow breadth is unhealthy, meaning that it may be unsustainable. That seems plausible on the surface, but unfortunately, many big market moves are started by a few bold first-movers. It’s not really unfortunate, if you owned those stocks or the ones that ultimately followed.
That said, yes, indeed there have been some big moves in a small handful of stocks lately, but there is an explanation. I hate to bring it up again, but there is that fast-expanding AI market, driving valuations of certain stocks higher. I have said plainly, and I will say it again. AI is real, it is huge, and we are just at the beginning. Clearly, I am not the only person that thinks so, and that is a huge market driver. If you combine that rapidly-spreading opportunity with hopes of an expansion-tilted Executive and Legislative branch about to take the reigns over in January, you get a powerful—but volatile kind of jet fuel capable of powering markets to new heights.
There are many voices that claim that stocks are overbought and expensive. Indeed, they are overbought, but that doesn't mean that they won’t stay overbought and go higher. With respect to their being expensive. Multiples can and they do expand. Additionally, as we learn more about future revenue opportunities for new technologies, we expect higher earnings growth in the future which, even without multiple expansion, propel current prices higher. It’s just math, stupid.
But there is something that can topple this well-crafted growth thesis. Can you guess what that is? Go on, give it a shot. [cue Jeopardy music here] Time’s up. If you guessed “interest rates,” you were correct. Remember, high and possibly increasing interest rates decrease the present value (or current stock price fair value) of future cash flows. Just some more stupid math, stupid. 🤓You don’t have to be a math whiz to remember what happened to your favorite growth stocks in 2022, do you. The S&P500 fell by -19.44 % while the S&P500 Growth Index fell by an even greater -30.09%. In that same year, the Fed Funds Rate went up by 425 basis points while 10-year Treasury Note Yields climbed by 236 basis points, and they already started climbing in late 2021 after the Fed’s hawkish pivot.
Ok, so have we established that your favorite growth stocks, the same ones that are pushing indexes to new highs in an increasingly complicated macro environment, rely on a benign interest rate environment to behave? Good. Do you know what is happening today in Washington DC… in the world of finance and economics? That’s right, the Fed’s FOMC meeting. Those buttoned up banking luminaries are going to discuss rate policy and vote on it tomorrow. But that’s not the big news. It is largely expected that the Fed will cut its key interest rate by another -25 basis points. However, what comes next is anyone’s guess. If we consult the futures markets, we see that the market is expecting another 50 basis points of cuts for the entirety of next year.
If you have been following me with all this, Apple’s closing stock price yesterday of 251.04, a fresh high, has those future expected interest rates baked in. Remember 👆, interest rates impact the prices of stocks, especially growth stocks. What do you think might happen if the Fed did not cut rates tomorrow? What if the Fed cuts rates as expected but warns us that the cutting is done for now? The Fed will release its quarterly forecast tomorrow, and with it the infamous Dot Plot. What if FOMC members’ projections show a growing number of them expecting interest rates to not only remain here, but maybe even… … higher? That will certainly throw some water on the fire that is in the bulls’ bellies. Oh, and in case you haven't noticed, longer maturity treasury yields are pressing higher in anticipation of Trump’s, expansionary, but possibly inflationary, policies that will start to become a reality on January 21st… maybe even the 20th. Why do I bring all this up now? Because it is important to recognize that higher interest rates and bond yields are THE SINGLE BIGGEST risk to the continued growth of not just your favorite equities, but all of them. Not just for the remainder of 2024, but possibly for all of 2025. Stay frosty, stay focused.
YESTERDAY’S MARKETS
Stocks muscled higher yesterday driven by tech, tech, tech as Trump paraded legendary tech investor Masayoshi Son of Softbank to press, as he showed up with a duffle bag filled with $100 billion in cash for investment in the US; we’ll take it! According to the latest, and important flash PMIs from S&P Global, US manufacturing continues to contract, but services are on the climb, making that knot that the Fed has to untie, more complex yet.
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