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    Higher rates don’t hurt growth stocks

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    good morning.On monday we Skeptical look There is general knowledge that rising rates mean lowering growth stocks. We are once again challenging the idea of ​​going with Screed on the ethical turmoil of the Federal Reserve today.

    Send us an email: robert.armstrong@ft.com When ethan.wu@ft.com..

    Growth Stock Death / Period Doctrine

    A popular story about growth stock is that growth stocks thrive when lower interest rates, especially lower real interest rates, increase the value of distant cash flow. Conversely, higher interest rates result in higher discount rates applied to distant cash flows and lower performance of growth stocks. In short, growth stocks are rate-sensitive due to their long duration.

    The theory is simple and compelling, and at first glance the data seem to be lined up. The graph below shows the 20-year Tips yield (substitute for real interest rates) plotted against the high-growth Nasdaq. Each dot is one day and plots the level of Nasdaq against the yield of hints for that day. The relationship is clearly visible. Hint up, Nasdaq down, and vice versa:

    But the more we think about this relationship, the less it looks. The link between rates and growth stocks is cyclical. It provides a forecast of growth stocks at the rising rate stage of the business cycle. However, Nasdaq and Tips change not only periodically, but also structurally. Major economic trends such as vitality and productivity are behind both rising growth stock prices and falling real interest rates. Both long-term trends can be caused by other causative factors.

    So I tried to separate only the circular bits by comparing Nasdaq’s daily returns to how much the chip yield went up or down on the same day. Simple Real Interest Rate-If the story of growth stocks is correct, the day when Tips went up is often the day when Nasdaq went down. This is what we found:

    Tips and Nasdaq charts

    There is a statistically significant opposite relationship here, but only a few. The red trend line slopes slightly downwards like never before. The days when the hints are up tend to be the days when Nasdaq is down, using the word “tendency” generously.

    The story of rate growth stock is not complete. The stock price is the discounted present value of future cash flows. Discount rates have a relatively large impact on cash flows farther than imminent cash flows. But I don’t know what the discount rate is. It fluctuates for a variety of reasons and future cash flows are not fixed. Therefore, this relationship is certainly not a market rule. This is not even a particularly useful rule of thumb.

    There are other, more intuitive reasons to doubt the lasting link between real interest rates and so-called “long-term” growth stocks. For many of them Monday.. But he didn’t mention the most important ones. No one thinks this way. “Oh, you see, real interest rates have risen four-tenth percent to minus 1.3 percent. The cost of money has really risen. Tesla is no longer the good investment I expected. I think. Sell! “

    Yes, real interest rates may be a factor in some trader models and spreadsheets. This may explain some of the recent pricing behavior. But believing this is different from believing that the relationship is driven by lasting financial logic. It’s not.

    The possible patterns are: “We’ve made a lot of money on these high-risk growth stocks. But now they’re down. We’re heading into a policy tightening cycle, which is usually bad for high-risk ones. That’s it. Sell! “

    Growth stock-term-real interest rate nexus is a thin idea that has been entrenched in the doctrine by repetition. Perhaps everyone needs to drop it. ((((Wu & Armstrong).

    Postscript: Richard Clarida

    Colby Smith’s Analytical piece The resignation of Vice-Chairman Richard Clarida of the Federal Reserve Board is good and you should read it. This led to his departure:

    Clarida had already been scrutinized in early October when it was discovered in February that it had moved from a fixed income fund to a equity fund between $ 1 million and $ 5 million. The deal took place a few days before the central bank announced a mass of stimulus to support markets and the economy at the start of the coronavirus pandemic.

    However, a previously undisclosed transaction, omitted because Clarida said it was a “careless mistake,” showed that it had moved more than $ 1 million from the same equity fund just three days ago. ..

    .. .. .. The Federal Reserve has previously explained that the nature of Clarida’s newly disclosed transaction, or the first suspicious transaction, was part of a “pre-planned rebalancing” of his portfolio. Refused to comment on what is related to.

    There are many subtle and slippery ethical issues faced by anyone with tradable insider information. In this case, there is nothing subtle. It’s ridiculous madness and the Fed looks crooked.

    You don’t have to consider what Clarida’s intentions were, whether it was really careless not to disclose the second transaction, or whether it really included a “pre-planned rebalancing”. Ethics is not only a matter of intention but also of appearance. He was involved in the Fed’s deliberations on a pandemic response, and at exactly the same time earned millions of dollars in bidirectional equity trading. Wow.

    Clarida created a big equity fund Sale Just as the market began to plummet, on February 24, 2020 (at least $ 1 million, less than $ 5 million). He made a large purchase (at least $ 1 million for the same thing) Stock fund)27th. 28th, Chairman Jay Powell announcement The Fed is ready to “use our tools and act appropriately to support the economy.” March 3, Fed Discount rate.. More stimuli were announced later in the month. The man was trading stocks extensively when he had privileged insights into the imminent and enormous government intervention in the economy. This is a catastrophe.

    Fed announced Change Since then, the trading rules require a 45-day notice of the transaction and a one-year holding period. This was necessary, but not enough. The Federal Reserve should not control their own portfolio at all.As I insisted PreviousThe wealth of key policy makers should be in trusts, and those trusts should be designed with the Fed’s policy objectives in mind. When the Federal Reserve steps into Ecclesville, it is unreliable to think that they have forgotten all of their own financial position. We need to make sure that their prejudices do not determine policy.

    One good reading

    How inflation creates Danger In the frontier stock market, “inflation is unpopular and can be volatile.”[and]Political changes can often lead to changes in ownership. In the worst-case scenario, minority investors can be largely wiped out. “

    FT asset management — The inside story of movers and shakers behind the trillion-dollar industry.sign up here

    Free lunch — Your guide to the discussion of global economic policy.sign up here

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