Hardly a day goes by without someone asking me, “Why do you like Jay Powell so much?” He will question whether I am somehow buddies with the Federal Reserve chair, or assume I knew him before he got the job. Nope. Barely knew him. I have spoken to him only once — and as part of a group — since he took the position in 2018. To understand why I like Powell, simply look at the arc of what has happened over the past year and you’ll recognize that his critics should be on their heels, not him. Go back 12 months, and all you heard from billionaire hedge fund managers — who are so delighted to go on TV because they are fawned over endlessly — was that Powell was much too loose with monetary policy and already too late in trying to curb inflation. But then he raised interest rates faster than anyone ever has — to the current targeted range between 4.25% and 4.5%. That’s up from 0.25% to 0.50% in March 2022, when the central bank made its first hike in this tightening cycle of 25 basis points. He has been as tough as nails. He has been relentless and on message. Jump forward to today, and you never hear that Powell is too soft and that he let inflation get away, even as so much of inflation has to do with foreign issues like China’s restrictive Covid policy and Russia’s heinous invasion of Ukraine. At the same time, Congress went along with President Joe Biden in spending a fortune on projects that are heavy on engineering when we have a huge shortage of engineers. Along the way, the disparity between the rich and poor grew quickly, with inflation hitting the latter much harder than the former. The wealthy, after all, allowed every car company and homebuilder to raise prices. Covid stopped the lower and lower-middle classes from bettering themselves. The whole situation, which was inflamed by a fractious press that Powell has chosen to deal with too regularly, was highly unusual. But he has handled it all. Which brings me to Friday’s market. The unemployment report released Friday morning showed wages grew slower than anticipated, increasing 0.3% on the month where economists expected 0.4%. Bonds did rise a tad and it looked like a relief rally. That’s until we got the Institute for Supply Management report showing the services sector contracted in December as new orders and production both declined. Where were the critics then? Why didn’t those who think Powell is a doofus speak up and say maybe he’s gotten it right? Those two highly predictive numbers were the real green lights to the rally. On top of that, rates showed not that we were going into recession — even as I heard that endlessly all day — but that there was suddenly optionality for the Fed; it is sure easier to stop a recession than inflation as any country in Europe will tell you. Now we are faced with the prospect of weaker earnings and number cuts galore. But we are also understanding that stocks have already reflected a lot of that negativity. A tale of two markets We have a truly bifurcated market though. We have a market that has one $3 trillion dollar stock in Apple (AAPL) and stocks worth hundreds of billions of dollars, and a lot more stocks that are $150 billion or less. We also have a division between technology stocks and everything else that is simply astounding in its dichotomy. Let”s contrast two of them: Amazon (AMZN) and Micron (MU). The first hasn’t preannounced weak earnings, just a sense that it must be worried because it hired perhaps as many as 300,000 more people than it needed. One look at the Macy’s (M) preannouncement Friday tells you the consumer isn’t profligate anymore. The other, Micron, has now told you three straight times that things aren’t getting better. In fact, they are getting worse. There is a bigger chip glut than ever and it has spilled over from personal computers, where the decline is as high as 19% year over year, to cellphones, where there is a worldwide slowdown having mostly to do with China and its zero-Covid policy. Since November, Micron’s stock is unchanged. But Amazon’s stock has actually fallen from the high $120s to $86. Why is that? Because an economy that is slowing will reach a point where the multiples of a stock like Micron will shrink until the earnings go lower. Then the multiples go up, but go against easy comparisons. That’s the bottoming process that happens this year. But Amazon? We have no idea what is the right multiple. We just know it is too high. The stock has been cut in half but it means nothing because the capitalization is almost $900 billion. That’s too big until the earnings are better, which it won’t be until there’s more cost rationalization. Period. Any company as big as Amazon that’s caught up in a recession is going to be worth less. It has to get the right multiple, that multiple has to go low, the earnings have to fall and only then will its multiple rise on faltering earnings but easy comparisons. In that sense, Micron is ahead of the mega-caps in the process of hitting bottom. How about Alphabet (GOOGL), Microsoft (MSFT) and Meta Platforms (META)? Same deal. Their market caps are too big, and with Alphabet and Meta the multiples are deceptively small because they are based on advertising and marketing and therefore are about to go down big. That’s the first thing you cut out in a recession. That’s also why the enterprise software companies are too highly valued: the prospective clients have done without them and they will do so again and new customers are hard to come by. Apple is the anomaly. Its market cap looks too big, but it might actually be right because of its service revenue. Meta Platforms’ market cap might be right, too. But TikTok has to be outlawed, more money invested in Reels and not the metaverse, the metaverse has to find a different delivery system, plus WhatsApp has to be spun off at 10 times revenue, meaning it is worth $100 billion. That’s a lot has that to go right. All of this is what will happen in the slowdown — but not recession — that Powell is engineering most deftly. There will be two markets. One is filled with the stocks that are too big and will remain share donors until they are given realistic multiples, see those multiples shrink, and then see them rise again because estimates are higher but comparisons are easier. The rest of the market, including stocks like Micron, will trade as it has in any recession. This is why I so resent those who say the market is “finished.” There is no “market.” There are two sets of companies: one with reasonable price-to-earnings ratios, and one with unrealistic multiples. The largest market caps still have unrealistic P/Es even as they have shrunk dramatically in the last year. The bottoming process for most companies has occurred, which is why I don’t fear the coming earnings season. But the bottoming process for high-growth tech is pretty unfathomable because it was never valued right in the first place. The bottoming process for the special purpose acquisition companies, or SPACs, and crypto is non-existent, along with almost any initial public offering from 2020 on. That could be as many as 1,000 stocks and a huge crypto presence. So, one market is actually quite good. The other market is horrendous. You just have to recognize that the horrendous part is in search of a price-to-earnings multiple, and until it gets one equal to the S & P’s 17 times earnings it might not happen. This is why we have been so concerned about Microsoft and Nvidia (NVDA) as they are in the process of rationalizing their multiples or rerated down. We are concerned about companies like Salesforce (CRM) with multiples that are still too high, we are concerned about Alphabet, Amazon and Meta because their multiples are illusory—too high given they are dependent on advertising. You simply can’t have enough of the rerated stocks, which are about to be winners as pressures from inflation, the dollar and supply chain ease and those headwinds turn into tailwinds. You can’t have too little of the mega-caps until the process of figuring out a real multiple begins. It will happen. It’s happening now for some companies. These are the ones I am most worried about. The good news? They represent a fraction of the companies out there. The bad news? They represent a gigantic amount of market cap that must be lost. I’d say we’re only halfway there. (See here for a full list of the stocks in Jim Cramer’s Charitable Trust.) 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Jim Cramer at the NYSE, June 30, 2022.
Virginia Sherwood | Tech Zone Daily
Hardly a day goes by without someone asking me, “Why do you like Jay Powell so much?” He will question whether I am somehow buddies with the Federal Reserve chair, or assume I knew him before he got the job.