The Baby Will Get Thrown Out With The Bath Water

The Baby Will Get Thrown Out With The Bath Water

The Federal Reserve will pursue some combination of modest interest rate hikes and potentially shrinking of its balance sheet / Quantitative Tightening in the coming weeks and months. The Fed’s “Too Little, Too Late” monetary policy will do little to curb inflation. However, the Fed’s modest tightening will likely continue to drive Equities lower – punishing even those stocks that are not richly valued.

Portfolio Managers often reduce their exposure across their portfolio in pro rata fashion. This means that shares in companies that are not necessarily overvalued get punished when a pronounced selloff occurs such as when the Tech Bubble burst in March/April 2000 and during the Financial Crisis of 2008/2009. It appears the mother of all bubbles is bursting as investors rotate out of high-multiple, momentum Technology stocks as well as Equities in general. The NASDAQ Composite is down 15% YTD, The S&P 500 is down 9% YTD and the Russell 2000 is down 12% YTD. Speculative investment vehicles such as Bitcoin and Ethereum are down sharply over the same period (BTC down 22% YTD, Ether down 35% YTD). These Equity indices and crypto currencies have further to fall once the Fed begins to tighten.

Steep selloffs such as the bursting of the 1999 Tech Bubble and the 2008-09 Financial Crisis punish not only richly-valued stocks, but most all equities feel the pain (albeit not equally of course). Fine Technology companies led by quality management teams that trade at reasonable valuations have been hit during this January 2022 selloff.

Take SS&C Technologies (ticker SSNC), for example. SSNC shares trade at 19x Enterprise Value to 2021(E) Operating Cash Flow. Hardly a rich multiple in our view. However, our bet is SSNC shares could trade 30% lower should the Fed increase interest rates to 2-3% over the next 1-2 years to say nothing of Quantitiative Tightening (the process by which the Federal Reserve shrinks the money supply by way of selling Government Agency securities. The Fed’s balance sheet currently sits at $8.9 Trillion).

Federal Reserve Balance Sheet: