10/3 Recap

As we approach the 200 day on the SPY, we seemingly get hit with a new negative datapoint daily and today it was the JOLTS number. You know my stance, I told you the market broke down a few weeks back and a period of weakness was coming. We’re enduring it now, earnings season begins next week with banks and usually there is some sort of run up into earnings for most names and I expect after this harsh selloff we will see some sort of bounce before earnings.

With that said, rates just keep going higher, we make a new high seemingly daily here and look at the chart below, it’s up 30% in 6 months. This continues to weigh on everything, the VIX finally nears 20 as well.

Now, I want to discuss a big misconception about rates. All we hear is the negative side of high rates. How it’s going to hurt every company. While it is crushing to the majority of companies who have to utilize borrowing, I’m here to tell you, there are many companies who will do very well with these higher rates. Below you will see what I mean. As you know Amazon is my favorite and constantly rates are mentioned in a negative light for them. What people don’t understand is these megacaps, they have so much cash and more comes in daily, where do you think it goes? In Amazon’s case almost $70B in cash is yielding them 4.2% now. That’s $3B/yr. That’s more than many darling companies make in profit. $3b/year will help them offset these fuel costs that are soaring now, but never do you hear an analyst even mention that. So long term I don’t think high rates are as big a negative as many make them out to be for megacaps. They will continue minting profits, they will continue investing all that capital in higher and higher yields as it comes in and they are getting free money that they never got the last few years. Not only did these large companies use the era of free money to grow to where they are now, but they now get the benefit of high rates to give them another profit engine that they never anticipated. In the case of a company like Amazon they’re just returning to all this cash generation and will generate unreal amounts of cash the next 2-3 years and if rates stay elevated they’re going to put away something like $150B at a 5%+ average yield. That is mind-blowing.

Here are the companies with the largest cash piles in our market that stand to potentially benefit from these higher rates.

Higher rates are not ideal, but you’ve always heard how they’re good for savers, and lots of these big companies have saved alot of cash the last few years, they aren’t complaining about high rates right now.

As you look at your book here, I think you really have to prepare for the reality that the market which already hasn’t gone up in 2 years, won’t do so for the next few years as well. Meaning the era of everything going up is probably over and now a select few companies will do well. You have to realize most companies were not designed to function with rates like this. Too many rely on too much debt to function and now that debt is eating away at the small profitability they had.

How you position yourself has to be with one thing in mind, will my holdings grow profits enough to potentially go up. If most of these companies grow profits single digits, I truly don’t see them doing anything. On the otherhand some will grow far in excess of that, you know how I’m positioned and a name like Amazon is looking at massive profit growth the next few years and my thinking is the equity will follow suit. It’s $125 today, 30% over the next 12 months puts it at $162 and 30% the year after puts its at $210 by the expiry of my calls. Nothing crazy, but 30% growth while profits grow well in excess of that is my base case. So look at your holdings and think about how their earnings will grow the next 24 months. If the earnings grow X, I would factor in the equity growing X x .6 just to be conservative. Meaning if a stock you hold will see earnings growing by 10% next year, I’d factor in a 6% move up off that because equities are going to have a very tough time growing inline with profit growth with yields like this.

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Today’s Unusual Options Activity

What you’ll notice today is far more puts bought than anything else, and considering how small a portion of the options market bears are, that’s pretty telling of where we are in the market.