The Federal Reserve’s hawkish rate reduces the signal to investors

Article content

As we enter 2025, we think there have been recent developments in the last two weeks that investors should start paying attention to, especially those who intend to repeat the market results of the previous year.

Article content

Article content

The meeting of the US Federal Open Market Committee (a branch of the Federal Reserve System that determines the direction of monetary policy) on Dec. 18 was really a mistake. The reduction of 25 points came as expected but there was disagreement among members as to whether the rates were appropriate. As a result, the Fed’s dot-plot (the central bank’s projection of its key short-term interest rate) will now point to another 50 basis points of rate cuts next year, taking rates to 3.9%, halving the previously expected 100 basis points of cuts. .

Article content

This sudden hawkishness sent a shockwave through the expensive US equity markets which have been dependent on large amounts of money from the US Federal Reserve to justify the current sky high rates. In addition, we have seen this in certain highly speculative pockets, such as cryptocurrencies, which appear to be beta strategies, meaning that the volatility of their returns is high compared to the broader market. Interestingly, it also had an impact on those companies that benefited from Donald Trump’s victory in the US presidential election, such as MicroStrategy Inc. and Telsa Inc.

Article content

For many of us professional investors, who generally do not participate in these markets, we are very concerned about the prices investors have been willing to pay for US mega cap stocks that have been leading and dominating the indices.

For example, take one of the largest US companies by market cap, Apple Inc., which recently traded at 41 times earnings, its highest price-to-earnings (P/E) ratio since 2007 when the first iPhone was available. released. This is despite moderate forward revenue and earnings growth forecasts and no new product launches expected.

Article content

Article content

It has now reached the point where the share of stocks trading at more than 10 times their market value has risen to levels not seen since the 2021 mania and tech bubble of 2000.

Article content

The big question is if the Federal Reserve has taken half the punchbowl and can no longer continue at its previous pace of easing, then how will these companies put back the financial results to support such high multiples?

Fidelity Global Macro Strategist, Jurrien Timmer, sums it up well in a recent X post: “By my calculations, the trailing EPS of the S&P 500 index would have been $211 instead of $251 if not for financial engineering (purchases and M&A) . That means the P/E ratio is higher by the same magnitude. The five-year cycle-adjusted P/E ratio (CAPE) would be 38.3x instead of 32.4x, which is higher than the peak of the dot.com bubble in 2000. It gives me relaxation.”

Article content

This is something that needs a lot of attention and leaves us thinking that maybe we are back to a situation where bad economic news is good news for these companies because it increases the chances of the Fed resuming its previous approach of easing?

Participating in the market before the introduction of price reduction after 2008, this does not go down well for us. The markets have become addicted to liquidity and this is unfortunate as it hides the really good companies that generate excellent free cash flow labeled as “yesterday’s trade” and therefore don’t get the attention they deserve.

Instead, it’s all about borrowing at low rates and buying stock for enhanced earnings growth for developers. Maybe one day we’ll return to the good old days of Benjamin Graham and start offering his famous book, The Intelligent Investor, to be read instead of kids taking pictures of it and throwing it in the trash can.

Until then, we should all be experts in monetary policy, since our positions depend on it.

Article content

Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc., operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in risk-managed portfolios, investment appraisal/oversight and advanced tax, real estate and wealth planning. The views expressed are not necessarily those of Wellington-Altus.

_______________________________________________________________

If you like this story, sign up FP Investor Newsletter.

_______________________________________________________________

Bookmark our website and support our journalism: Don’t miss the business news you need to know — add financialpost.com to your bookmarks and sign up for our newsletter here.

Article content