Decoder Model Portfolio Update: $34 Trillion and Counting
In this week's model portfolio update:
Apple kicked off the first trading day of the year with a 3.5% drop (a gigantic move for a company with a nearly $3 trillion market cap). The supposed cause: A downgrade from a Wall Street bank (Barclays), with a share-price target lowered by one dollar, based on pessimistic demand factors that investors already knew about.
The real reason for the drop: Apple's valuation is impossible to defend, and Barclays merely stated the obvious in a way that spurred a rush for the exits. At the same time, the market on the whole got off to a rough start: Stocks and bonds have not kicked off a new year with such sharp declines in tandem since 2002.
Some of this may relate to the fact the "Magnificent Seven" now look like the Nifty Fifty on steroids — the Nifty Fifty were a group of 1960s growth stocks, supposedly buyable at any price, that were taken out and shot post-1972 — and some of it may relate to the U.S. national debt topping $34 trillion for the first time. The trouble with the debt comes down to interest-rate expense. At an estimated $1.1 trillion, the cost of debt service is now hundreds of billions more than the national defense budget and is likely to eat more than a third of tax revenues.
Given the debt and deficits situation, it remains the case that a 10-year yield below 4.0% makes no sense — unless the U.S. economy is headed for a recession in 2024, in which case a much-worsened earnings outlook would drag down wildly overvalued stocks. (AAPL would look more like a buy than a sell at, say, 13x earnings, but at 30x earnings that is more than a 50% drop from here).
If the bond market is wrong about an incoming recession, the 10-year yield should start climbing back toward 5.0% or higher again, as a robust U.S. economy would keep the Fed from cutting interest rates too many times (while also keeping a bid under inflation). At the same time, profit expectations around artificial intelligence look way overdone — Nvidia aside, where the gains are fully priced in, the profits from generative A.I. will take some time to materialize, and it is entirely possible the net impact of A.I. is deflationary (which could then make equity multiples shrink).
All told, we don't know if the bond market is right about the recession, but if it is, the rosy crop of corporate profit outlooks will not hold up. Alternatively, if the bond market is wrong about the likelihood of recession in 2024, the euphoric drop in yields brought about by Janet Yellen's gamesmanship (which can only last so long) should reverse itself, with yield pain translating through to the deteriorating fundamentals of big tech.
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