Jim Cramer: What history tells us about this kind of bond yield fear

Where are we in this bond-related selloff? Are we a third through? Two-thirds? Or are we where we need to be to start buying?

As I said, I’ve studied all of the interest rate scares we’ve had over the decades and this one pretty much follows the shape of the one where the Fed feels pressure to raise interest rates on a very low basis.

These fears all have the following in common:

1. Inflation seems to have gotten out of hand due to some measures. In this case it is wood, which has doubled in a year; buyer, which is really China’s demand, higher than $ 4; and oil, which is north of $ 60. They are visible and they say the Fed must act.
2. A significant number of stocks have been created that do best with stable prices, like us, and these stocks have become toxic because they are considered dangerous places because they have no real income or sales. These types of stocks need low inflation to pay off in the long run and they don’t get that.
3. The Treasury is under attack for overspending. Here we have the massive stimulus package that comes at a time when the pandemic seems to be running its course because of science. But spending is often at the heart of these fears.
4. We are getting shortages because of the higher rates that the Fed does not control.

Now, before I get into everyone else, let me remind you that this is all happening in a vacuum in the bond market. When you read Warren Buffett’s letter this weekend, you can see rampant capitalism and how little these four points mean. They’re noise to him, and I don’t even think he hears it, although his shocking $ 11 billion write-off on Precision Castparts is a reminder that no one is immune from “the moment.” Buffett paid $ 32 billion for this excellent aircraft parts company six years ago. It was a high price at the time, too high, as Buffett admits.

Still, the takeaway from Buffett’s letter, as always, is that if you take a long-term view, things will turn out okay on balance and this time he hasn’t chastised anyone for trying to do it at home. Thank you.

Now let’s look at the issue. There are many investors, especially new investors, who do not understand the relationship between bonds and stocks. To make it easy there are three intersections. First, rising interest rates are creating competition with equities, and some would argue that the average stock’s dividend flow is already threatened by fixed-rate bonds due to the “big” interest rate movement. I think this is canard. Bonds are still very unattractive. Read Buffett again if you disagree. Second, interest rates are necessarily a signal of the future and the future is that we will have inflation and inflation is bad for stocks. Explaining why it’s bad is a bit like explaining why a soccer team is bad. It loses a lot. You lose a lot of stocks when inflation is bad. The third is the hardest: the yield trigger algorithms that pull individual growth stocks down while stabilizing cyclical stocks at the same time. The latter can’t get higher due to the downward pull of S&P futures from large macro funds that want less exposure. But the cyclical countries have the advantage and because of the years of dormancy, there are very few and they don’t even equal a tenth of the growth stocks out there. They cannot lead.

So where are we? I don’t want to dismiss the most optimistic cases: the last ten minutes of Friday were terrible and yet the rates didn’t go up, so it’s possible we are further along than we think.

But I think that is too optimistic. We are not through the stimulus yet. The Fed has not been pressured for what happens when that money is distributed and we are fully vaccinated. Only the variants, the malignant variants, can derail the vaccination plan and I think they just won’t be that serious because our scientists are now one step ahead of the gang.

So what happens then?

I think when we have these fears, no one has enough money on the sidelines to take advantage of them and your fellow shareholders are your enemy. They don’t want to be tight, a la Buffett, maybe because they are in options or because they have margin or because they think the market has been manipulated or because they don’t understand the interplay of bond markets.

What they don’t understand is that while rates are low, even a miniscule move from the 13% of 40 years ago or the 7-8% of so long in the 90s, that means, on a percentage basis , big money gets scared.

Plus, we’re not yet when Jay Powell gets a question about what happens when everyone gets vaccinated and he says, “You know what, we cut rates to zero a year ago, it’s time to let them go higher to go.”

Until you hear that you need to keep some powder dry. Note that I didn’t say “if you hear that”. At some point, it would be pointless to keep rates low if the economy grows and ten million people are recruited.

So the long answer is that this shock won’t end until Powell breaks with his current vision.

That means we can be really hurt for some stocks.

What kind of shares?

Five different types.

First, there are the companies that did well last year and maybe not so well this year. You can see this now, in real time, play with Costco (COST) and Walmart (WMT). I know some are impressed by the higher labor costs these companies are incurring. Others are concerned that now that non-essential retailers are back, these companies will have to fare worse.

I say that’s why you’ve already had such a rapid decline. Walmart is only 13 points higher than where the pandemic started. Do you think it’s worth less than that moment when so much of its competition has now been destroyed? Of course not. Same with Costco. These are two great companies with stocks that will get higher over time because they make so much money. That’s not even comprehensible at this point for some of the sketchy holders. So you can be sure that, just like a Clorox (CLX), these companies will see their stocks flirting with charts that would indicate that no value has been created. We buy them for Action Alerts PLUS because it is simply not true that they are worth less than when the pandemic started.

So I’m saying some stocks are already close to where they’re going and they need one more quick leg that might be going too fast to buy.

Then there is a second cohort, the Salesforce (CRM) / Workday (WDAY) group. These are companies that are starting to get really great sales at a time when it’s almost unimaginable for that to happen. These are deferred income companies, so most couldn’t see the breakout of either company over the past few quarters. Are the sales absurd? Not at all. Not when the rates are higher. The big concern here, if you use the 2015-2016 paradigm, will be when one of these cohorts misses and blames the economy like LinkedIn did back then. I don’t see that happening, so the 30-40% drops won’t happen, IMO. Which again means this group is a bargain if we have the fast leg down I expect, when Powell is put under too much pressure and says the magic words. Stocks will bottom out for that, but we’re not there yet.

Third group: companies that are ASSUMED to benefit from higher rates. I don’t want you to think for even a second that they will. The only stocks that are going up in such a fright are pure commodity stocks like copper companies and they are going up until China, the main customer, stops buying or we get more mines to open, which is happening now. The stocks that people SAY will rise are the cyclical stocks and the banks, but that’s a canard. If interest rates get higher and the Fed doesn’t follow suit, banks will make a little extra on your deposits, but inflation will cover that up until the income is reported. The cyclical rally won’t last as too many people worry about missed numbers as rates get higher. These companies are sloppy leaders anyway. There are too few of them.

Fourth, higher yields. These must drop to levels where the returns are even higher before they are less risky to own. You can watch Pepsi (PEP) or Coke (KO) or Pfizer (PFE) or Merck (MRK) and you can see what happens. American Electric Power’s (AEP) is also a good pain proxy. You can’t see it, but you know it’s happening. I like this group here because they are now starting to overcompensate. That’s because there is a realignment to stocks that do better when the economy opens up – just a handful – and these stocks are the fuel for that move. Even lower, however, is the password, but not much lower.

Then there is the last group, the newly minted companies and the companies based on the hope of EV or alternative energy or SPACs that companies have found, but the SPACs are overvalued relative to the companies – Churchill Capital IV (CCIV) – Lucid Motors becomes Front and Middle. I have no idea how low these can go. There are too many. They are not tracked. They are really part of the Wall Street hype machine. Some can stick with it because they have a good concept: check out Fisker (FSR). But it is on a case-by-case basis and there is still a lot of money to be lost here.

I know that I am not setting out a scenario that makes things worth buying. But I do think the group that hits bottom first will be the high-growth, profitable Salesforce sector. Why? Because any scare ends with these stocks going up, that’s why you have to pay attention and start buying them, actually now as they tend to anticipate everything I just wrote.

Remember, I’m not trying to give you hope, just history. But history is hardly ever wrong. I think it won’t be wrong this time either.

(Costco, Walmart, and Salesforce.com are holdings in Jim Cramer’s Action Alerts PLUS member club. Want to be notified before Jim Cramer buys or sells these stock? Read more now.)