This market is split in two and only one part is worth owning
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Hardly a day goes by without someone asking me, “Why do you like Jay Powell so much?” He’ll wonder if I’m somehow friends with the Federal Reserve Chairman or he’ll assume I knew him before he got the job. No. I barely knew him. I’ve spoken to him only once, and as part of a group, since he took office in 2018. To understand why I like Powell, just look at the arc of what’s happened over the past year and you’ll recognize that his critics should be on his heels, not him. Go back 12 months, and all you heard from billionaire hedge fund managers, who are so delighted to be on TV because they are incessantly fawned over, was that Powell was too loose on monetary policy and too late to try to fix it. curb inflation. But he then raised interest rates faster than anyone, to the current target range of 4.25% to 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 by 25 basis points. It has been as hard as nails. He has been relentless and on message. Flash forward to today, and you’ll never hear that Powell is too soft and let inflation slip away, even when much of the inflation has to do with foreign affairs like China’s tightening anti-Covid policy and the heinous invasion of Ukraine. by Russia. At the same time, Congress went along with President Joe Biden by spending a fortune on engineering-intensive projects when we have a severe shortage of engineers. Along the way, the gap between rich and poor grew rapidly, with inflation hitting the latter far more than the former. The rich, after all, allowed all the auto companies and home builders to raise prices. Covid prevented the lower and lower middle classes from improving themselves. The whole situation, which was inflamed by a contentious press that Powell has chosen to deal with all too regularly, was highly unusual. But he has handled it all. Which brings me to the Friday market. The unemployment report released on Friday morning showed wages growing slower than expected, rising 0.3% in the month economists had expected 0.4%. Bonds rallied a bit and it looked like a relief rally. That was until we got the report from the Institute for Supply Management showing the service sector contracted in December as new orders and production slowed. Where were the critics then? Why didn’t those who think Powell is a fool speak up and say he maybe he got it right? Those two highly predictive numbers were the real green lights for the rally. On top of that, rates weren’t showing that we were going into a recession, even when I heard that on and on all day, but suddenly there was an option for the Federal Reserve; Surely it is easier to stop a recession than inflation, as any country in Europe will tell you. We now face the prospect of weaker earnings and number cuts galore. But we also understand that stocks have already reflected much of that negativity. A tale of two markets However, we have a truly bifurcated market. We have a market that has a $3 trillion dollar stock in Apple (AAPL) and hundreds of billions of dollars worth of stocks, and many more stocks that are $150 billion or less. We also have a split between tech stocks and everything else that is just amazing in its dichotomy. Let’s compare two of them: Amazon (AMZN) and Micron (MU). The former hasn’t posted weak earnings, just a feeling that he must be worried because he hired perhaps 300,000 more people than he needed. One Look at the pre-ad from Macy’s (M) on Friday that tells you that the consumer is no longer wasteful. The other, Micron, has now told him three times in a row that things aren’t getting better. In fact, they are getting worse. There is a greater glut of chips than ever before and it has spread from personal computers, where the decline is as much as 19% year-over-year, to cell phones, where there is a global slowdown that has mainly to do with China and its politics. from zero covid. In November, Micron’s shares were unchanged. But Amazon stock has actually fallen from $120 to $86. Why? Because a slowing economy will reach a point where the multiples of a stock like Micron will shrink until earnings go down. So the multiples go up, but they go against easy comparison. isones That is the background process that occurs this year. But Amazon? We have no idea what the correct multiple is. We only know that it is too high. The stock has halved but it means nothing because the capitalization is almost $900 billion. That’s too big until profits are better, which they won’t be until there’s more cost rationalization. Period. Any company as big as Amazon that gets caught in a recession will be worth less. You have to get the multiple right, that multiple has to go down, earnings have to fall and only then will your multiple go up with faltering earnings but easy comparisons. In that sense, Micron is ahead of the mega-caps in the process of bottoming out. What about Alphabet (GOOGL), Microsoft (MSFT), and Meta Platforms (META)? Same deal. Their market caps are too large, and with Alphabet and Meta the multiples are deceptively small because they are based on advertising and marketing and are therefore about to drop big time. That’s the first thing you eliminate in a recession. That’s also why enterprise software companies are highly valued: potential customers have done without them and will again and it’s hard to find new customers. Apple is the anomaly. Its market capitalization seems too large, but it might actually be correct due to its services revenue. The market capitalization of Meta Platforms could also be correct. But TikTok has to be banned, 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 10x revenue, which means it’s worth $100 billion. That’s a lot has to go well. All of this is what will happen in the slowdown, but not in the recession, which Powell is more adroitly engineering. There will be two markets. One is full of stocks that are too large and will continue to be shared donors until they are given realistic multiples, see those multiples go down, and then see them go up again because the estimates are higher but the comparisons are easier. The rest of the market, including stocks like Micron, will trade as it has in any downturn. That is why I am so annoyed by those who say that the market is “finished”. There is no “market”. There are two sets of companies: one with a reasonable price-earnings ratio and one with unrealistic multiples. The largest market caps still have unrealistic P/Es, even as they have fallen sharply in the past year. The background process has occurred for most companies, so I do not fear the upcoming earnings season. But the background process for high-growth technology is pretty unfathomable because it was never properly priced in the first place. The fund process for special purpose acquisition companies, or SPACs, and cryptocurrencies is non-existent, along with almost any initial public offering starting in 2020. That could be up to 1,000 shares and a large crypto presence. So a market is pretty good. The other market is horrible. Just acknowledge that the horrendous part is looking for a price-earnings multiple, and until it hits one equal to 17 times S&P earnings, it may not happen. That’s why we’ve been so concerned about Microsoft and Nvidia (NVDA) as they are in the process of rationalizing their multiples or re-rating them. We worry about companies like Salesforce (CRM) with multiples that are still too high, we worry about Alphabet, Amazon and Meta because their multiples are illusory, too high since they depend on advertising. You just can’t get enough of re-rated stocks, which are poised to be winners as inflation, dollar and supply chain pressures ease and those headwinds turn into tailwinds. You can’t have too little of the mega-caps until you start the process of calculating a real multiple. It will happen. It’s happening now for some companies. These are the ones that worry me the most. The good news? They represent a fraction of the companies that exist. The bad news? They represent a gigantic amount of market capitalization that must be lost. I would say we are only halfway there. (See here for a full list of Jim Cramer’s Charitable Trust shares.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable foundation’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTMENT CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY, TOGETHER WITH OUR WAIVER. NO LIABILITY OR FIDUCIARY DUTY SHALL EXIST OR BE CREATED BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTMENT CLUB. NO SPECIFIC RESULT OR BENEFIT IS GUARANTEED.
Jim Cramer at the New York Stock Exchange, June 30, 2022.
Virginia Sherwood | CNBC
Hardly a day goes by without someone asking me, “Why do you like Jay Powell so much?” He’ll wonder if I’m somehow friends with the Federal Reserve Chairman or he’ll assume I knew him before he got the job.