It’s possible to be too negative. Today gives many of my go-to growth names a welcome bounce . . . not enough to completely erase Friday’s carnage, but it’s definitely a step in the right direction.
And while the mood is still bearish, it’s encouraging to see some investors taking calculated risks again. While interest rates are climbing, they aren’t necessarily the end of the world.
But it’s scary when the Fed keeps making threats about hitting the economic brake hard. People who’ve forgotten how an aggressive rate feels see nothing but disaster ahead.
Market veterans know this is far from the end of the world. Wall Street has weathered aggressive Fed cycles before . . . and made a lot of money buying exactly the kind of stocks that are getting beat up now.
You don’t have to take my word for it. I’m going to let history make its argument in a few minutes.
For now, however, this morning’s surge reveals that interest rates don’t necessarily make the entire world go around. The near-term interest rate environment hasn’t gotten any better.
Bond yields are actually rising again and are right at the edge of 3% as I write this. After a year of the market conditioning itself to dread every tick above zero, you’d think we’re already past the point of no return.
And yet a lot of the stocks that people say are most likely to get choked by higher interest rates are hanging onto their gains as well. Block (SQ) is up. Paycom (PAYC) is up.
Battered high-growth stocks like Affirm (AFRM) and Roku (ROKU) are up. Reading between the lines, I think the market has finally remembered that there’s a playbook that works in a rising-rate environment.
When interest rates are climbing, you need to invest in companies that are accelerating faster than the Fed is braking. That’s how you stay ahead.
And over time, the most disruptive growth stocks can compound their edge and make courageous shareholders rich.
Maybe you weren’t around in mid-2004 or have just forgotten what drove the market back then. I’ve picked that time frame because back then we were just exiting a period of abnormally low interest rates . . . and bracing for an aggressive tightening cycle ahead.
The Fed pushed overnight rates from 1% to 3.25% over the first year of the cycle. After the second year, the bottom of the yield curve had climbed all the way to 5.25%.
Throughout the process, Wall Street fretted about the curve flattening. But for three years, the economy kept humming along.
And while the market as a whole ground its gears, a handful of once-obscure companies convinced hardened investors that they were worth grabbing at valuations that wouldn’t be shocking today.
Start with Apple (AAPL), which at the time was in the earliest stages of its renaissance after nearly collapsing in the dot-com era. Steve Jobs was still alive back then and he was back in charge.
At a moment when interest rates were on the brink of a multi-year leap, AAPL was barely profitable, earning the equivalent of $0.0075 per share in fiscal 2004. If investors saw that number today, they would probably crowd the exits to get away.
Yet that miserable profit supported a 42X trailing earnings multiple because smart money could see that iPod sales were taking the bottom line up 300% a year. That growth rate defied the Fed and just about everything else.
At the time, of course, AAPL was only an $11 billion stock, barely a blip in a world dominated by names like GE, Exxon and mighty Microsoft. You had to be passionate to buy and hold Apple then. It was a contrarian play.
But say you weren’t a member of the Steve Jobs cult in 2004. A little company called Starbucks (SBUX) was available for what was then around $48 a share.
No showy gadgets. No charismatic founder at the helm. Just a burgeoning network of coffee shops and a product line pinned at the right price point to make a lot of money.
SBUX was earning the equivalent of $0.23 per share. Adjusted for splits along the way, you had to pay about 50X trailing earnings to get in . . . despite interest rates, the yield curve and everything else.
This was only a $19 billion company then in a world of $300 billion industrial juggernauts. You had to go out of your way to own SBUX. And yet with an earnings growth rate of “only” 50% a year, the stock plowed right past the Fed.
Are multiples too rich to handle? Were they too rich back in 2004? Go up the food chain . . . Microsoft (MSFT) was floundering, with uneven earnings growth like what Amazon (AMZN) is undergoing now.
MSFT was still worth 26X trailing earnings. Even defensive names like Pfizer (PFE) and Home Depot (HD) supported multiples in the 16-20X range.
Some of these companies underperformed in the tightening cycle. On the whole, the established giants struggled to achieve any kind of lift at all.
Now names like AAPL and SBUX are the established giants. What new favorites will the coming cycle create?
We don’t know exactly which stocks will defy the Fed, but today’s list of winners is probably a pretty good signal that the future doesn’t look bleak at all.
Winning on Wall Street is a cycle. And at this point, even a lot of the giants look cheap on an absolute basis.
MSFT is on a hot streak . . . and yet is only a little more expensive than it was in 2004 when it was facing an existential crisis and Bill Gates was on his way out.
HD at 18X . . . almost exactly where it was 18 years ago. While there isn’t as much room left for growth, those who bought at $33 back in 2004 are probably not complaining now.