The R Word

By David Nelson, CFA CMT

On the heels of 4 chaotic weeks Apple (AAPL) provided enough of a beat and positive forward guidance to shore up investor confidence, even if just for a day. After several round trips, the selling ended about 2:30PM Friday, setting up a 90-minute surge into the bell.

While the volume didn’t match trading earlier in the week it was still well above normal. For now, last Monday’s intra-day low becomes an important level for traders. Living above it, the glass is half full. A sustained break below and it’s back to the bunkers. We have another big week of earnings ahead including giants Alphabet (GOOGL) and Amazon (AMZN).

Fed Target is to get Real Rates back above Zero

Data by FactSet

Last week Jay Powell made it clear the FOMC is going to push real rates back above zero. The only way to do that is to lift the Fed Funds rate and hope inflation responds accordingly. Add the fact that they are going to start the process of unwinding a massive balance sheet and you have at least an explanation of the recent massive swings in equity markets.

Investors are adjusting to life without an implied Fed Put for support.

Until Friday, this was a big challenge for long duration equity. Most equity models start with the risk-free rate and when it’s zero you’ll pay almost anything for growth. I continue to think that despite Friday’s rush to the other side of the boat and back into many non-profitable companies, investors will want some food on their plate in the form of earnings, cash flow and or dividends. We’re not talking about Microsoft and Apple here. I’m talking about the dozens of companies on the NASDAQ $30-50 Billion in size with no E in the PE.

You don’t have to dump all of your growth stocks. However, the anacronym is, Growth at the Right Price not GROWTH AT ANY PRICE.


The healthcare sector has been lagging the market since the election. There was understandable concern the administration was going to push hard against drug pricing and investors didn’t want to step in front of that train. To a large degree that hasn’t happened. Valuations are undemanding and you can pick up solid cash flow in Biotech’s like Vertex Pharma (VRTX). They have a powerful franchise in the treatment of Cystic Fibrosis an inherited life-threatening disease. Trikafta was the standout this quarter and will go a long way to drive the top and bottom line. At just 16x forward earnings and 8x sales it fits the GARP mold perfectly.

The R Word

Data by FactSet

I look at the yield curve above and get a very different message than the one implied by recent strong GDP numbers.

It’s not that the long end of the curve isn’t moving higher. It has over the last month but it’s not keeping pace the front end. The yield spread between 10 and 2-year paper has been declining for close to a year and the spread between 10’s and 5’s is at the lowest levels since the pandemic lows of 2020.

Data by FactSet

If this continues and the yield curve inverts investors are going to worry about something even scarier than inflation. The R word or recession will be a topic of conversation across equity desks.

Data by FactSet

The sell off in equity markets may be an early warning sign that current earning’s estimates for this year are wrong! With little exception commentary on conference calls includes references to rising input costs and supply chain constraints. Growth could come in a lot less than expected. Current consensus for S&P earnings is about $222. Three months from now we could be looking at a very different number.

*At the time of this article some funds managed by David were long AAPL, GOOGL, MSFT, VRTX and AMZN.