The market is still digesting the Fed rate hike. The Fed obviously doesn’t want to hike too quickly, causing a recession. However, it can still do so with a policy error. I don’t think the Fed will make as bad of a mistake as last cycle. says Don Kaufman, co-founder of TheoTrade.
Last cycle the Fed had rates low, encouraged people to get adjustable rate mortgages and then jacked up the Fed funds rate quickly. It doesn’t take a PhD to understand what a disaster that was.
Sure, the Fed had more room to cut rates last cycle, but it created a massive crash in the economy to be in that position. Because investors have the recency bias from the last hike cycle, they think hike all cycles are terrible. They only end in disaster if the Fed makes a mistake. It’s time to sell when the Fed is done with hikes; we’re not there yet.
The chart below shows the current market since the first hike compared with how the market did during periods where hikes were slow and periods where hikes occurred quickly. While the market does well when hikes occur quickly because it signals the economy is strong, it also increases the probability the Fed is making a mistake.
The chart shows the past five hike cycles are all in the fast category. Three of them have been paired with stock market crashes, although the October 1987 crash occurred right after the hike cycle started, so it didn’t cause the crash. Investors who are scared about a crash occurring like those three periods should be feel better about the fact that this is a slow hike cycle, unlike those ones. However, the blue line shows there is a decline, on average, at this point in the slow hike cycle.
GDP estimates
The chart below shows the various forecasts for American GDP growth. I previously stated that many private economists expect a recession in late 2019. However, the government would never forecast a recession.
As you can see, the IMF and the OECD have a more positive view than the FactSet economic estimate. The expectation is 2018 will be a great year for growth and 2019 will be slightly weaker as the tax cut boost loses its effect. This estimate is behind the Fed’s goal of raising rates quicker this year than last year.
The hope for the bulls is Powell is bullish on economic growth but doesn’t take it too far with rate hikes.
Concentration by sector: tech & consumer discretionary
Clearly, if the big tech stocks fall, it will hurt the market. The key point to understand is that the big tech firms don’t have a larger effect on the overall market than usual.
One way analysts mislead investors about the effect of the top tech stocks is they show their percentage of the market. Since Facebook (FB), Apple (AAPL), Netflix (NFLX), Alphabet (GOOGL), and Microsoft (MSFT) have increased, their influence has increased.
However, the correct way to look at the influence of the top firms is to compare the previous top firms to the current ones. As we’ve previously shown, this proves the market isn’t more concentrated than before. The chart below takes this a step further. It shows that even in the tech sector, the top 5 firms don’t have a bigger influence on the overall sector than usual.
While the technology sector isn’t highly concentrated compared to historical precedent, the consumer discretionary sector is more concentrated than it usually is. As you can see in the chart below, only during the tech bubble there was more more concentration.
The top stocks in this sector are:
--Amazon (AMZN), which has 21% share
--Home Depot (HD)
--Comcast (CMCSA)
--Disney (DIS)
--and Netflix (NFLX).
The bottom 4 of that group have 21% share. I wouldn’t be surprised if this concentration surpasses the 2001 peak because the internet is driving retail to be more competitive on price. If this chart included Wal-Mart (WMT), which is a consumer staples firm, it would be even more concentrated. Almost no companies can compete with Amazon and Wal-Mart on price.
Most crowded trade
Keep in mind, when I say the FAAMG stocks don’t influence the market more than usual, I’m not saying to buy them. I’m saying the market isn’t affected by them more than unusual. The market always has leaders which push it higher. It’s impossible to have each stock increase at the same rate.
When utilities, telecom, and consumer staples underperform, it’s a sign the market is doing well because the risk on trade is working.
The chart below shows the global fund managers’ response when asked for the most crowded trade. The latest response as of March 18 was being long FANG and BAT. BAT is Baidu, Alibaba and Tencent. This is the same response as last month, but the percentage saying this increased by about 10% to about 40%. This survey has a pretty good track record.
As you can see, the short volatility trade was the most crowded in January. Two weeks later, the short volatility trade exploded. Long bitcoin (BTCUSD) was the most overcrowded in September and December 2017; it peaked in January. In the past 2.5 years, the highest reading was when the fund managers said the dollar was overbought. The dollar index fell about 5 handles in the next 4 months.
With the recent decline in Facebook, the long FANG and BAT trade might be unwinding. As I mentioned, the biggest negative against them is more regulations.
Conclusion
The market has been reacting to the points I mentioned in this article, namely Facebook’s negative headlines and the Fed’s recent meeting.
The Fed will be near the end of its rate hike cycle at the end of this year. Facebook is facing regulatory issues as I expected. The good news is that this is a slow hike cycle; the fast hike cycles were consistent with the past two stock market crashes. The other good news is that the top tech stocks don’t have a higher than usual influence on the market or the tech sector.
