Did Something Happen Last Week? - Weekly Blog # 670

 

Mike Lipper’s Monday Morning Musings

Did Something Happen Last Week?

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

Great Discomfort, Almost Panic, Large Growth Funds, Long Treasuries

Market participants apparently reacted to the further steepening of the US Treasury yield curve, with higher interest rates for longer maturities. (This was not a surprise to me, I have been focusing on higher inflation for a while. This week the JOC-ECRI Industrial Price Index reported a +47.91% rise from over a year over year. Also, my wife noted that supermarket prices are rising.) 

The impact on large “growth” stocks, as measured by large-cap growth mutual funds, declined by mid-single digits for the week. The connection between rising long-term Treasury yields and stock prices for companies with large amounts of cash and relatively low debt, surprised much of the public and some in the media. In theory, growth stocks are valued at what the market believes are their future stock prices, discounted by the cost of money until they are sold. The lowest discount rate used is the yield on long-dated treasuries. Thus, the reaction to the steepening of the Treasury yield curve makes growth stocks less valuable. Approximately ten of these stocks have been the engines of superior price appreciation in large institutionally managed portfolios.

Investors do not reveal the motivation driving their decisions and commentators consequently we use circumstantial evidence to ascribe motivation. As a skeptic, I look for other non-publicized explanations. 

Questioning the Gospel

The new administration has been fortified by the naming of the Treasury Secretary, a former chair of the Federal Reserve and former labor economist. For more than a year the previous administration believed in the long-term continuation of low interest rates. This belief comes from their indoctrination into Keynesian economics and has become the accepted dictum for governments since President Nixon announced, “We are all Keynesian, now”. Without any constitutional or legal authority, the function of government has now been determined to be the management of the economy to produce full employment. 

In John Maynard Keynes’ “General Theory of Employment, Interest and Money” published in 1936, he laid out the principle of the government (the people) funding contra-cyclical spending, providing money to hire out of work people through deficits or higher taxes.

Apart from the recent Trump tax-cuts, I don’t believe there have ever been tax cuts, other than as a “peace dividend” after a military war. Part of Keynesian policy was to set interest rates low during a recession and raise them in good times. To no one’s surprise there has never been an example of deficit reduction in good times. 

Keynes’ policies resulted in lenders being unable to make up for losses from defaults or late payments, which were critical in restoring the capital of lending institutions. That Keynes came up with this scheme in the mid-1930s is not surprising. In the US and around the world there was a movement toward more authoritarian government. Is it possible that this week’s “taper tantrum” was some glimmer of thought that governments might be responsible for the level of employment through low interest rates under Keynesian economic principles? Only time will tell, but very surprisingly it could happen now or in the immediate future.

What the Market Says?

The first two months of 2021 is now in the record books. The five leading mutual fund peer groups through Thursday night were:

   Natural Resource Funds         +26.38%

   Energy Commodity Funds         +24.80%

   Base Metals Commodity Funds    +18.36%

   Global Natural Resource Funds  +16.37%

   Small-Cap Value Funds          +15.83 %

Clearly, we are seeing energy and base metal prices rising, although some believe it’s not the result of short-term shortages. What is perhaps most interesting are the gains of the small-cap value funds. For years, small caps underperformed larger caps and “value” underperformed “growth”. On a year to-date basis the average small-cap fund has gained more than the average mid-cap fund, which in turn was up more than the average large-cap fund.

This change in performance leadership is broad and meaningful. The NASDAQ composite is leading the Dow Jones Industrial Average (DJIA) and the S&P 500 in both directions. I believe the reason for this is that most large index funds and closet indexed portfolios focus on NYSE listed stocks in the two senior indices. The more volatile NASDAQ attracts a higher percentage of traders and has a greater number of would-be growth companies.

The price chart for the NASDAQ is completing a “head and shoulders” reversal pattern, with the price pattern of the other indices not far behind. Valuations are high for the S&P 500, which has a price/earnings ratio of 21.5x, compared to 15.8x ten years ago. Also, because of both lockdowns and cash from the government, savings are 20.5% of after-tax income.

Investment Conclusion:

We may be near to both a short-term top and possibly a major revision in the long-term thinking of investors. 

Share your views, please.

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2021/02/debt-inflation-and-markets-weekly-blog.html

https://mikelipper.blogspot.com/2021/02/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/02/adjust-investment-tools-for-next-phase.html

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