“No word matters. But man forgets reality and remembers words.” — Roger Zelazny, Lord of Light
Two weeks ago, when we wrote:
“Consider, the not-so-unimaginable case of long-term US treasury yields going to zero. If in concert with a total collapse in bond yields, earnings yields of the highest quality companies — overwhelmingly consisting of US tech companies — also collapse, say to 1 per cent. That implies that high quality names will trade at 100 times price-to-earnings.”
Our expectation was for this to playout over a period of months along with the usual waxing and waning of markets.
The very sharp moves in large cap tech names reminds us of Charlie Munger’s utterance from the 2014 Berkshire Hathaway Annual General Meeting, “if you think you understand, you’re not paying attention.”
Facebook: Misleading Narrative
On Wednesday upon seeing Facebook rally more than 8 per cent, one well followed financial analyst made the following remark:
“FB gained 8% ($68 billion in market cap) today on this news:”
The news in reference being a CNBC article with the headline, “Facebook warns Apple’s iOS 14 could shave more than 50% from Audience Network revenue.”
At face value, the remark and news suggest that markets are behaving irrationally, which of course they might be, but most definitely not because Facebook was up on bad news. In absolutes, the changes Apple is making in its latest iteration of iOS may be negative for Facebook but in relative terms it may actually make Facebook stronger than its competitors, especially those competitors that do not possess the infrastructure and financial clout of Facebook.
The next update to the iPhone’s operating system, iOS 14, will require apps to obtain users’ permission, via a pop-up window, before gathering data that allows tracking and ad targeting. The “Audience Network” combines Facebook’s proprietary user data with data gathered from smartphone users’ usage of apps to display more targeted adverts within third-party apps. This ability to combine two data sets enabled Facebook to display highly targeted adverts for which it could then charge a premium and at the same time pay apps a premium for providing the advertising space.
Facebook will no longer be able to combine two datasets and therefore will be unable to display highly targeted adverts in third-party apps on the iPhone.
The changes in iOS 14 do not in any way impact Facebook’s ability to display targeted within its own apps.
If advertisers are looking to spend their advertising budgets on targeted rather than spray-and-display adverts, then the ‘real estate’ within Facebook’s own apps will inevitably become more valuable. We think that is the most likely outcome.
The Fed Shifts
From the Wall Street Journal:
“The Federal Reserve approved a major shift in how it sets interest rates by dropping its longstanding practice of pre-emptively lifting them to head off higher inflation, a move likely to leave U.S. borrowing costs very low for a long time.
It won’t lead to a significant change in how the Fed is currently conducting policy because it had already incorporated the changes it formally codified Thursday.
But the shift marked a milestone. Had the strategy been adopted five years ago, the Fed would have likely delayed rate increases that began in late 2015, following seven years of short-term rates pinned near zero. It amounted to the most ambitious revamp of the central bank’s policy-setting framework since the Fed first approved a formal 2% inflation goal in 2012.
By signaling Thursday it wanted inflation to rise modestly above its 2% target, the Fed revealed how the global central-bank principle of inflation targeting, widely adopted over the last quarter century, might have outlived its usefulness in a world of lower interest rates.”
The Fed has dropped the “bygones inflation targeting” approach, where 2 per cent inflation was the target irrespective of what had transpired previously. The problem with this approach, according the to Fed Chairman Jerome Powell is:
“If inflation runs below 2% following economic downturns but never moves above 2% even when the economy is strong, then, over time, inflation will average less than 2%.”
The obvious takeaway from the Fed’s policy is that monetary policy will stay loose for longer. Specifically, the Fed will actively seek out higher inflation and will utilise aggressive policy responses to downturns as it has done in response to the COVID-19 pandemic.
A little less obvious is that the Fed is effectively abandoning its dual mandate of low inflation and full employment. This mean that that a tight labour market no longer implies a tightening policy response as it previously has done based on outputs from the Phillips curve. Any tightening will be a function of rising inflation or inflation expectations.
Many are taking the shift in policy as a signal that higher inflation is imminent and that real assets should benefit. We are not convinced as the entire edifice upon which today’s capital markets are built is the negative correlation between bonds and equities. If that breaks and the two asset classes become positively correlated then 60/40 portfolios, risk parity and other similar strategies will have to significantly scale back leverage. Inflation is what breaks the negative correlation.
Inflation is the enemy, just not in the way most of us think.
Thank you for reading!
This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.