Dec. 20, 2022

This Market Has Lost Its Leadership

The stock market has lost its leadership. The stocks that led the long bull phase. For a couple of decades, we have witnessed the ascendancy of these all too familiar, big-tech stocks; they’ve been the ones that far outpaced all the rest. We all know their names by heart: Apple Computer, Amazon, Microsoft, Meta, and Alphabet. Together they set the pace, created or at least purchased, the innovation that drove the economy.

These were the go-to stocks that every prominent investor had to have in their portfolios. Every portfolio manager needed to put these companies into their fund. To an exceptional degree, the big five measured up to every manager’s criteria. How could you pass up on the market’s largest capitalized, best-performing stocks?

With their vast market caps, they were highly liquid, trading more than enough shares each day that a manager could feel safe in buying or selling without disrupting the market.

Their sheer size created a highly symbiotic relationship between these big five and Wall Street. Wall Street bid up their shares. And then the Street was rewarded with outstanding performance as those shares appreciated.

On the other side, these astronomical valuations gave the five excess capital to purchase smaller companies and continue at the leading edge of technology. Amazon purchases Whole Foods and Zappos, and Facebook/Meta purchase Instagram. Google buys YouTube.

For three decades, these five and Wall Street became richer and richer as the financial world grew even more concentrated. The wealthiest companies in America became even more wealthy. And the band played on and on.

They say that no one rings a bell at the market top. And that’s true. But in September, the music suddenly stopped. Subtly, almost imperceptibly, the money stopped flowing into Apple, Amazon, Microsoft, Meta, and Alphabet.

There was nothing dramatic. It appeared to be a pause. Not the beginning of the most significant decline in decades for some of these companies.

In order of their stock’s decline, the most robust company is also the most valuable; Apple Computer has only declined 25% from last year’s highs. Microsoft is down a third in value, while Alphabet is down 40%.

And then we come to the two stocks that are hurting; Amazon is down 55% from its highs, while Meta Platforms is down an astonishing 70%.

These are earth-shattering results and represent a titanic shift in our financial system. Now markets often see around corners that we cannot. These horrible results could be portending something yet to be in my field of view.

But there is one elephant in the room that we need to explore. And that elephant is this current spate of higher interest rates. You may be thinking: interest rates? How can that be? These companies, with one or two exceptions (Amazon), have very little corporate debt. So higher interest rates should not affect them. You’re right. It is not likely that higher interest rates will affect Apple, Meta, Alphabet, or Microsoft’s corporate results.

Except for Amazon, I’m not worried about any of these companies becoming burdened with higher interest payments.

But it’s different for their sponsors, the private equity funds, hedge funds, and all the other funds and pools that utilize leverage to enhance their returns.

Wall Street is riddled with all types of loans and debt. Many of the most well-known money managers and investment portfolios would have just half the assets without borrowing. They all utilize leverage to enhance their returns.

Take away its borrowing, and that trillion-dollar Hedge Fund is suddenly a half-trillion-dollar fund.

In short, this is a monumental shift in the investment world. We last saw something like it decades ago. The process of deleveraging Wall Street is already well underway. The beginning was when the Street began to off-load significant investments, such as the big five, to reduce leverage.

As we speak, traders, managers, and analysts are receiving news that their year-end bonuses will fail to live up to expectations. The big banks are already cutting back, often by eliminating positions and, occasionally, entire divisions.

Last week the Federal Reserve began preparing us for these high-interest rates to last much longer than previously assumed. Keep those rates too high for too long, and we could see many funds, private investments, or even banks go out of business.

As this year ends, the performance of the big five stocks, Apple, Amazon, Alphabet, Microsoft, and Meta, have told us that significant changes lie ahead. At least some of that change comes from higher interest rates.

But there will be much more to this story before it is over. 2023 promises to be full of surprises.

Econ Briefs

The Old Carry Trade. I was reminded this morning of the significance of the Carry Trade a couple of years ago. This morning, the Bank of Japan announced its latest interest rate decision. Like last month, and every month for the past six years, the BOJ held its primary interest rate at a negative 1/10th percent.

That’s right, borrow money from a Japanese Bank, and you’ll pay next to nothing in interest. After all, the Japanese bank’s cost of funds is negative, so you’ll pay a meager loan rate after their markup.

Every American Hedge Fund and their brother figured out that borrowing from Japan and investing in America was the way to get wealthy. And so they did. The Japanese carry trade was the hottest thing on Wall Street for years.

Unfortunately, it is not such a hot deal today. A couple of American regulations were put in place that cooled things off. But most importantly, as we discussed, the American Equity Markets need to cooperate with stocks like Amazon and Meta Platforms, down 50% and 70%, respectively. It doesn’t matter how cheaply you can borrow if your investments are losing money.

So, the bottom line is that the Bank of Japan maintains its meager, extremely stimulative interest rate to help its economic recovery. Stimulative monetary policy is precisely the opposite of the US. In this country, the Fed has the brakes firmly planted as it seeks to cool off our economic growth in its misguided fight against inflation. The Americans need to boost our sagging economy, just like the Bank Of Japan is doing.

We’ll see the latest in Building Permits and New Housing Starts later this morning. Wall Street looks for a slight bump higher in these numbers. But remember, starts and permits are off nearly 20% from their highs of 9 months ago.

In earnings reported so far, defensive stock General Mills is trading lower on their results. And then, after the markets close, we will get results from sports company Nike, delivery services, and FedEx.