- Martin Sosnoff
How To Play Federal Reserve Myopia
Nobody’s record is good on forecasting interest rates. But with 10-year Treasuries at 1.3% there is much room on the upside. The least you could say today is bonds are uncompetitive with stocks unless you own BB debentures with 5 years’ duration. At least you get 5% on your money.
In some parts of the world such as England, Germany, and Japan shorter maturity paper has carried a negative yield. In the last year the rate of return on our US Treasuries is near zero. Traditional pie chart wealth managers have kept client funds at least 30% in the fixed income sector. Banks like JP Morgan Chase (NYSE:JPM) have underperformed in their portfolios for several years.
Overall, I’d say the Federal Reserve Bank contributed to the rate of inflation in the country, past 50 years, but not today. For example, there were some fifty changes in the discount rate between Alan Greenspan’s ascendancy in 1987 to his retirement in 2006. A few years ahead, I’d expect to see 30-year Treasuries yielding 4.5% with inflation nearing 3%.
This is not a healthy matrix for stock market evaluation which, historically speaking, shows a price-earnings ratio of 16, not today’s plus-20 multiple. Back of mind is the concept of necessary fallibility. Charts can’t pinpoint inflection points. Black Monday, 9/11 and the Cuban missile crisis blindsided all of us. I’ve learned to respect vague, queasy feelings in my belly as the best leading indicator of big trouble ahead.
The ultimate leading indicator is the Federal Reserve Board’s published notes, quarterly, which still remain relatively unconcerned on inflation’s levitation. I’d expect to see real worry surface in the next couple of quarters.
The International Monetary Fund, after studying its baseline forecasts for the world found their forecasting errors were so great as to make them practically useless for implementing policy initiatives. Staff economists blamed a world rich in economic and geopolitical upheaval—oil for example, for missed turning points. Alas! Isn’t all this what we have today?
What’s so revealing is that looking at the forecasting record of our GDP, you never get trendline growth (3%) more than 18% of the time. If you exclude quarters with negative growth, our GDP expanded at a 4.6% rate, not 3%.
Historically, changes in interest rates run large and long lasting. It’s what I see in the cards today and why I’m overweighted in financials like Citigroup (NYSE:C) and Goldman Sachs (NYSE:GS).
You can’t just own value stocks because they look cheap, what we call a "value trap." Growth stocks, when they run out of gas, sell as value stocks and nobody cares. If Apple (NASDAQ:AAPL), Alphabet (NASDAQ:GOOGL), Facebook (NASDAQ:FB), Microsoft (NASDAQ:MSFT) and Amazon (NASDAQ:AMZN) lose their luster, they’ll be cut in half or worse and sell at book value.
For armchair investors who dare take ultimate risk, my short list embraces General Electric (NYSE:GE), Enterprise Products Partners (NYSE:EPD), Goldman Sachs, even Halliburton (NYSE:HAL). I own US Steel (NYSE:X), Macy’s (NYSE:M)’s and Freeport-McMoRan (NYSE:FCX) too, but they’re up on stilts. Let somebody else worry about whether copper prices zip higher to justify Freeport-McMoRan as a legitimate spec.
Last time I checked Facebook sold over 6 times book, but I didn’t worry. The stock now making new highs is actually reasonably priced compared with Alphabet and Amazon. Facebook’s R&D spend runs near 20% of revenues. R&D for most tech houses is closer to 10% to 15% of their revenue base.
Major corporations can go through all the motions of an active operator, but, cycle-over-cycle, generate little or no free cash flow. Earnings need to be reinvested in the business to stay competitive. Coal operators remained in a growth mode for decades, but emerging environmental concerns have destroyed valuation.
When my old buddy, Joe Rosenberg, joined Larry Tisch at Loews (NYSE:L) they argued over whether Joe could give his office a fresh coat of paint. Tisch never lost his frugal mindset. When it was a seller’s market for media properties Larry peeled off CBS. Later, he bought Diamond Offshore Drilling (OTC:DOFSQ) when it was a buyer’s market for drillers selling at 10 times normalized earnings power. It helps when properties you look-see are misunderstood and under-owned.
Carl Icahn may finally hit pay dirt in his ragamuffin energy plays, but I’ve concentrated on MLP’s still yielding 6% or better, like Enterprise Products Partners (NYSE:EPD), Williams Companies (NYSE:WMB) and Kinder Morgan (NYSE:KMI). They’re buoyant traders. Cyclicals comprise half my holdings, inclusive of financials. I’m over-weighted in technology, 30% assets, while MLP’s gather nearly 20%.
Consider, bottom of the market, early 2020, obvious cyclicals like US Steel, Alcoa (NYSE:AA), Halliburton, Freeport-McMoRan, even Macy’s sold in single digits but nobody cared. Since then, this paper doubled, tripled or quadrupled while super growthies, tech houses, just traced the market’s recovery of 100%. Analysts now debate whether Freeport-McMoRan, trading at $36, is worth $50 in the next 12 months.
When I look back to the dot com debacle in 2000-2001, when NASDAQ fell below 2000, my most productive investments were in tobacco, HMO’s and insurance—all counter cyclical plays. All sold near book value. Today, I’m disinterested.
My crash helmut stays buckled, but the history of interest rates is on my side. The Fed is about to admit it’s behind the curve on money market rates and owns too much in the fixed income sector, like mortgage-backed debentures. Don’t rub your eyes too long. Ten-year Treasuries won’t hang around 1.3% for much longer. My belief in an elongated economic cycle puts this paper at 3%, maybe a year out, where I see inflation ticking, too.
Martin Sosnoff and managed accounts own: Facebook, Amazon, Freeport-McMoRan Copper, Halliburton, Macy’s, Citigroup, Enterprise Products Partners, US Steel, Alcoa, Williams Companies, Kinder Morgan and Goldman Sachs.