Inflation, Tech Stocks, and Beta

Good morning from an overcast Cebu!

I hope you’re well and thriving.

Just looking at the charts yesterday and reading The Journal today got me thinking about tech stocks in general.

Of course, the ride has to end sometime.  Is it now?  No one can be absolutely sure, but tech stocks have taken a breather lately.

It’s (Probably) Time to Protect Your Portfolio

The stock market had the collywobbles again yesterday.

It’s pretty funny trying to parse through all the explanations as to why the equity markets are feeling a bit fragile at the moment.

The big story, of course, is the non-transitory inflation the Biden administration has stirred up with its asinine policies.

The market not only anticipates inflation, but has been seeing inflation in the economic numbers, most recently in the CPI readings.

Many of you invest in stocks, and I’m just going to give my opinion on the overall market level. I will mention some stocks in this article, but these are not recommendations by any stretch. 

They are just to illustrate the examples that I want to give to you.

The FAANNGG+TM Stocks

The problem with the S&P 500 is this: as a market capitalization-weighted index, it gets pulled in the direction of the largest companies in the index.  (Not the highest stock price, which is how the Dow works.)

Let’s see how the big guys have fared since September 1st.

While Netflix and Tesla defied gravity, the rest of Big Tech wasn’t so lucky.

Here’s where this becomes a problem.

If you look at the top constituents of the S&P 500, you will see Apple, Microsoft, Amazon, both classes of Alphabet (Google’s parent company), and Facebook.

The top 8 stocks in the S&P 500 – all tech stocks – comprise over 25% of the index.

As a result, they pulled the index in the past year, way, way up.

If you look at high beta stocks, which tech stocks tend to be, they are the best performing constituents this year, according to a great article on Seeking Alpha.

Briefly, beta is the measure of the stock’s moves compared to the market’s moves.  According to Investopedia, the more technical definition is “beta is a measure of the volatility—or systematic risk—of a security or portfolio compared to the market as a whole.”

If you look at the chart above, you’ll see Apple’s beta is 1.22.  That means, on average, Apple’s stock moves 22% more than the market on a given day.  So if the market is up 3%, AAPL “should” be up 3.66%.

Tesla has an insane beta of 3.64.  That means if the market was up that same 3%, TSLA “should” be up 10.92%.

One thing to keep in mind is that stocks never move precisely like that; beta is just an estimate.  Two, it works the other way when the market is down, as well.

High volatility stocks, who control the market’s main index seeing massive headwinds?

Not a recipe for easy riches.

September was a disaster for the S&P and the NASDAQ.

As you saw yesterday in the monthly review, the NASDAQ underperformed the general market. Now, this is going to have significant knock-on effects.

An Idea That Pays Dividends

So my first idea is this, sector rotation. I think it’s time to at least go underweight tech stocks. That doesn’t mean tech stocks will crash, or Facebook’s going to go to zero, even with its technical issues, which sent the entire Facebook ecosystem down for a few hours yesterday.

But I do think going a little bit lighter on tech is a smart move. As I mentioned in the monthly review, inflation hits tech stocks historically, and it seems to be the case now. 

Facebook was down very hard yesterday. Amazon has been a dog all year.

Here’s the year-to-date performance:

So it looks like a rotation out of this sector, or at least going underweight, would be a smart move.

What you may want to replace those stocks with would be the lower beta dividend-paying stocks that will at least give you cash flow, if not capital gains, over the interim period.

Stocks like AbbVie, Abbott Laboratories, Johnson & Johnson, Coca-Cola are all excellent examples of those kinds of stocks.

They’re not going to shoot the lights out. You’re not going to have any substantial capital gains, but you will be able to earn a nice dividend.

Warren Buffett famously did this after the crash of 1987.

Now, you’re probably not going to earn nearly $700 million in dividends after holding a trade for almost 40 years.

But it’s a telling example. Here’s my Warren Buffett Coca-Cola trade piece from capitalism.com.

Inflation Will Stick Around

The other thing I want to talk about is how inflation doesn’t look like it’s going to be abating anytime soon.

As you remember, in 2020, Russia and Saudi Arabia went into a bit of a kerfuffle over oil prices. 

Russia just opened the spigots up, which sent oil futures negative for a time.

Now it seems like Russia has gotten a bit more sensible about the whole thing.

Russia likes slightly lower oil prices than usual because they have restructured their economy not to rely on a $100 oil barrel.  Very smartly done by President Putin.

The reason why they want a lower oil price is that if their prices are too high, they lose market share in Europe.

And what they want is a high market share in Europe.

One, because selling to rich people is a smart thing.

And two, they will exercise much more control over Europe’s energy policy via that supply, which is undoubtedly in the Kremlin’s best interests. 

That it rubs Washington’s nose out of joint immeasurably must tickle Putin pink.

The Russians decided to go along with OPEC’s decision not to open the spigots and drive the oil price down.

Now, Brent crude oil (out of the North Sea) is trading roughly $81 a barrel, its highest level since 2014.

West Texas Intermediate – the US benchmark – trades at $77.

The United States doesn’t like that because general energy prices rise.

So Russia’s decision greatly displeases Washington, but it will keep a natural bid under the oil price for the time being.

If oil remains high, you’re going to see inflation remain high, which means labor costs will probably remain high, which means it’s bad for tech stocks.

So it looks like a smart bet to rotate into dividend stocks.

Incidentally, the three classes of dividend stocks are as follows:

    1. Dividend Kings. These companies have consecutively increased their dividend payments for at least 50 years… so at least a half a century.
    2. Dividend Aristocrats. This is a list of about 50 stocks that have consecutively increased their dividend payments for at least a quarter of a century. 
    3. Dividend Achievers. These are 274 stocks that have consecutively increased their dividend payments for at least a decade.

MarketBeat.com lays them out nicely.  You can find them there in the top menu under Financial Calendar > Dividends.

Again, this is not a specific stock recommendation. I’m not allowed to give you those!

This is just a market overview.

Until tomorrow, have a great day.

All the best,

Sean

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