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"Lock those interest rates; they're only going up." It was the summer of 1998, and that was the advice I received from my Dad. We locked at 7.25%. Though I was fresh out of college, I knew this was cause for celebration. But hindsight is 20/20, and we know that rates continued to decline through today. Earlier this year, I locked seven-year rates at 3.25%. Despite the constant march of lower rates, the advice has remained the same from anyone who worked through the 70's and 80's. "Wow, that's low, but better lock those rates; they're only going higher."
The 1970s all over again… or not
Perhaps we will finally go into a new uptrend of higher rates and prove my Dad’s prediction correct. Today, inflation seems rampant, and the Fed has committed to raising rates as high as necessary to stamp it out. It sure sounds like the 80's all over again.
Except it is already a very different story. The Fed’s commitment to stamping out inflation at the risk of unemployment is different from the 1970s policy. Paul Volker wasn't appointed as Chairman until 1979, and it wasn't until 1981 that he restrained the money supply in the face of high unemployment. Inflation finally eased off in 1982. Before that policy, it was higher rates when inflation ticked up and lowering rates when employment ticked down. We did this see-saw motion through the 60's and 70's with the prioritization of the socially popular employment goal.
If we believe our current Fed chairman, Jerome Powell, he says he understands this history and is committed to taking the same course as Paul Volker who finally ended inflation. If Powell doesn't blink and stays with it, we would be fighting inflation at the beginning instead of letting it build for a decade. He’ll have to soldier on in the face of a recession and high unemployment even if inflation is not yet under control. How that will affect inflation this time around is to be seen, but it should avoid the mistakes made in the 1970s.
Materials prices are already making meaningful moves down. Copper, wheat, corn, and natural gas have come down 30% or more in the last month or two. The Fed seems to have the market's confidence, which is a significant step in the right direction.
Is this the bottom?
Our big unknown is what kind of recession we may be headed for and what that will do to the stock market. I see an even more frequent question with the markets down roughly 20% from their highs: Are we at the bottom yet?
My quick answer is, of course not. I think we’ll have another leg down in the market of 15-20%. Making these predictions or thinking of a bottom is mildly entertaining, but it has no place in any investing strategy.
Warren Buffett buys stocks when a company has long-term competitive advantages and is 30% below what he thinks it is worth on a 10-year discounted cash flow basis. By that definition, you may believe we are there with a company you know and understand. If the stock price drops more, that is inconsequential to him (and you) and may warrant additional purchases.
Most stocks are still in their downtrends. Some of the best performers are merely going sideways and almost none are going into new high ground. The market-topping and bottoming is a process that can easily span 18 months until it changes direction. There is no need to rush back in or buy a bottom.
Strategy going forward
That being said, my strategy is to get into big winning stocks that will vastly outperform in a bull market and may even buck the trend in a downtrend. I see a few interesting breadcrumbs, namely Chinese stocks and U.S. Biotech. Chinese stocks were the first to decline and have come down big. Alibaba is a prime example of a stock that was down 77% over a year. It has since risen 55% and entered a classic sideways price movement. This is a textbook setup of a stock's behavior before starting a new uptrend. But when that new uptrend occurs is anyone's guess. Other Chinese stocks are acting similarly. The ones on my watch list are FUTU, BABA, PDD, BYDDF, LI, and DQ.
I also see some positive kernels in the U.S. biotech space. The biotech index may have bottomed and there are a few biotech stocks nearing new 52-week highs, such as United Therapeutics, Vertex Pharmaceuticals and Harmony Biosciences. This is a volatile sector and tough to trade given its announcement risks, so I would recommend the indexes such as XBI or IBB. But like all stocks and sectors, I think Chinese and biotechs are a wait-and-see but are the most bullish-looking areas I see right now.
Outside of these broad categories, there are only two individual stocks right now that are of interest to me: Privia Health Group and Olli's Bargain Outlet. Both have done well in the face of the index's decline. Privia is a classic-looking growth stock that could rocket when the weight of the market lifts if it keeps up its sales and earnings growth. Ollie's Bargain Outlet may benefit from high inflation, and other retailers needing to dump their oversupply to discounters. Ollie's also has an aggressive growth plan with new store openings.
Our Holdings
As of the writing of this newsletter on the last day of June, FBG Capital is 100% in cash. The maximum holdings I have had since the last quarter was 5% invested. Per my previous recommendation, I am surprised that Gold has remained relatively flat for over two years. Maybe that will change soon, but the strong dollar is holding it back for now. I view Gold's stubbornness to go higher as a good sign overall.
Looking Forward
We need inflation to come down and the market (and the Fed) to believe it will stay down. Historically the market does not bottom until the Fed starts to lower interest rates. If I had to guess, we will have a 3rd leg down in the market indexes by November taking us about 20% lower from today, which will be the bottom. But after that, we will start putting in time, have some great bear rallies, perhaps test the lows here and there and wait for inflation to subside and the federal reserve to lower rates. Given the Fed's greater commitment to stamping out inflation over maximum employment, we could get to a new bull cycle earlier than the fear headlines predict. But earlier could still mean late 2024. It is best to remain optimistic and flexible. I, for one, am watching interest rates closely and happily give advice as any good citizen of my generation should. "Don’t lock those rates, they’re only going down.”