Two Generational Trends Reverse: Fed Inflation Policy and the Bursting Technology Bubble

39 years ago, the 10-year US Treasury yield peaked at 15.312% and interest rates began declining. On August 27th, Federal Reserve Chairman Jerome Powell presented the Fed’s new policy that “will likely aim to achieve inflation moderately above 2 percent for some time.” This marks a profound shift in a four-decade policy – the inflation fighting posture championed by Federal Reserve Chairman Paul Volker now takes a backseat to fuller employment. The critical consequence of this policy change is that future returns on stocks and bonds will no longer be bolstered by declining interest rates. The investment management dogma of the 60/40 stock bond allocation model is being undermined by this Fed’s new policy. New asset allocation models emphasizing alternative investments like commodities and hard assets will need to be adopted. If inflationary tolerance broadly permeates central bank policy, a failure to reallocate could have profound investment consequences. All investment pools, especially long term vehicles such as pensions, retirement accounts, endowments, and taxable investments could be impacted.

The chart below by Nobel Laureate Robert Shiller shows the four-decade decline in interest rates and the corresponding rise in stock and bond prices to today’s record-high levels. This new Fed policy shift could reverse nearly four decades of abnormally high stock and bond returns.

The 2020 Technology Bubble has Burst:

Today’s parabolic price rise in technology stocks mirrors the accelerating rise which preceded the 2000 dot-com boom and stock market bubble. The 2000 tech bubble led to a two and a half year 83% decline in the NASDAQ 100 Index (QQQ).

On September 1st, the NASDAQ 100 Index gapped open. Gap openings are rare events when a stock or index leaps to a new high price leaving a price gap on a chart. Gaps are the result of extreme or “panicked” investor behavior. On August 31st both technology darlings Apple, Inc. and Tesla, Inc. split four for one and five for one. This non-economic event created so much investor commotion that it led to outages at major brokerages – a clear example of “irrational exuberance.”

Those who don’t remember history are condemned to repeat it,” philosopher, George Santayana. 
We acted on gap openings in tech stocks on March 23, 2000, the day before the tech bubble peak. That rare market moment is an indelible memory since I managed a New York based technology hedge fund at that time – Helsinki Advisors, LLC – which had appreciated 112% in five months and had grown to $24 million dollars under management. (The fund’s inception was on November 4, 1999 five months earlier.) The technician who flagged this rare market action said, “get out of tech and stay out.” We did. Helsinki Advisors, LLC hung in there with stunning returns before ultimately succumbing to the NASDAQ’s epoch 30-month 83% crash.

With this profound experience, we again advise reallocating away from technology stocks, based on their parabolic appreciation, gap openings and extreme valuations. Failure to manage this massive tech bubble could have lifestyle or career changing consequences for some and possibly many.

Below is a chart of the NDX100 or QQQ that shows an identical parabolic sector move to the 2000 tech bubble.

Source: Wellington Shields
The table below shows the rapid rise in the QQQ index during both 2000 and 2020. In both cases, huge technology stock bull markets preceded five months of accelerating and unsustainable price appreciation. Both periods saw unprecedented Federal Reserve stimulus: 2000 due to the dreaded “Y2K” global computer glitch and 2020 due to the COVID-19 crisis. Both times, technology companies dominated the economy and social fabric of the country.
Source: Income Growth Advisors research.
“FAANG stocks”, the acronym for Facebook, Amazon, Apple, Netflix and Google shares are emblematic of this bubble. Their parabolic rates of appreciation are both extreme and unsustainable and are charted below along with the QQQ.

Trouble Ahead!

Today’s stock market is historically overvalued. Warren Buffett’s so-called favorite indicator suggests equity valuations have never been so expensive. The Wilshire 5000 Total Market Index was valued at $35.96 trillion as of Wednesday’s close and the second-quarter US GDP was $19.4 trillion. Based on those figures, the Buffett indicator now stands at 185% – an historic high. This indicator is pictured below.
The ratio of the stock market to the US economy’s gross domestic product has expanded from about 20% to 185% a nine times multiple expansion since the early 1980s.

COVID-19 Data Continues to Improve:

The COVID Tracking Project charts below show new cases, since July when the southern states’ “second wave” peaked, are again declining. This “second wave” followed New England’s March-April deadly cycle. While today’s case rates are higher than April’s, hospitalizations have not exceeded the hospitalization levels in the first wave. This implies improved medical treatment and mitigation. Critically important are the lower and declining death rates while total cases are at all-time highs. This demonstrates COVID-19 case lethality has significantly declined.
This pandemic will end when a vaccine is developed and distributed. The chart below shows five major vaccine candidates that could become available in the next 6 months. Given the lock down and its massive economic restrictions to combat COVID-19, the approval of the first vaccine will lead to a major acceleration in economic activity.

Market Impacts from COVID-19:

The COVID-19 pandemic has had global economic consequences. Over the next year, many of the companies which were most negatively impacted by the virus should rebound the most. Airlines, restaurants, hotels, and travel exemplify those industries which will enjoy improving revenues and earnings. Investment money will rotate from COVID-19 beneficiaries to the COVID-19 hobbled businesses.

This valuation disparity is neatly shown in the chart below which compares the price of world growth stocks to world value stocks. Our rotation forecast into value stocks and out of growth stocks will add momentum to the decline in FAANG stocks typical for post-bubble price action.

Source: KCI Research, Ltd.
Income Growth Advisors is not alone in anticipating an epoch rotation away from growth to value. Commodity specialists, Goehring and Rozencwajg details below how Schlumberger, in 1980, was then the iconic darling of the markets much like FAANG stocks today.
“We have now completed a full investment cycle in energy that began forty years ago. In 1980, investors worried the world was running out of oil…. A massive reversal in investment capital flows is about to take place. Back in 1980 no one could possibly envision that Schlumberger would ever trade below its 1980 price in the years to come—but 40 years later it does. The FANG stocks today are in the same position as Schlumberger in 1980. History is about to repeat itself and few investors are positioned to profit from it.”


Beyond rotating out of technology and growth into value and cyclical stocks, we continue to be particularly positive on natural gas stocks. Due to the double Black Swans of OPEC+ and COVID-19, energy stocks have been devastated and oil drilling has collapsed. Therefore, associated natural gas production – a common byproduct of oil drilling – has declined significantly. The combination of structural supply constraints and the economic recovery will lift natural gas companies and end a 15-year bear market on the cleanest of fossil fuels.
We have been buying Antero Resources Corporation (AR), Antero Midstream Corporation (AM), Southwestern Energy Company (SWN) and Range Resources Corporation (RRC) and believe these natural gas stocks could rise 100-300% in the next two years if our natural gas forecast proves accurate.This letter has briefly analyzed several complex market concepts, in particular, two major trend reversals. The shifting monetary policy of the Federal Reserve and the end of the 2020 technology bubble will have significant long term consequences across a broad range of public and private assets. Consequently, we encourage any questions you might have. This is a pivotal investment moment.

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The information expressed on our website is based upon the interpretation of available data. The data being presented was obtained or derived from sources believed to be accurate, but Tyson Halsey and Income Growth Advisors, LLC

(IGA) cannot and does not guarantee the accuracy of these sources which may be incomplete and/or condensed. The data and information presented is provided for informational purposes only, and is not offered as a basis for trading in securities nor is it offered for that purpose.

Nothing contained herein should be construed as a recommendation to buy or sell any securities.

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All Rights Reserved.

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