A few weeks ago, while having a conversation, the question as to how the federal funds rate affects the price of stocks was posed. I thought on how to answer this in a simple fashion and happened to come across a passage in one of Bridgewater Associates daily observation packets that stated “If you let the return of cash get above the returns of assets, money will move from assets to cash and the economy will contract. In fact, as riskier assets will require higher returns, assets will have to have risk premiums (i.e, will have to be priced to have higher returns than cash), which means that the assets will probably fall in price before the return of cash comes to equal the expected returns of the other assets.”
You see, if a government bond gives you a rate of return of 4% and a common stock can get you a rate of return of 8% then money is likely to purchase the common stock in an attempt to get a better return. Although, if the government bond suddenly gives you a rate of return of 8% and the common stock can get you a rate of return of 8% then money is going to choose the bond due to the “safety” when compared to that of the common stock. This is due to the fact that the common stock “can get” a rate of return of 8% which implies uncertainty, while the rate of return on the bond is guaranteed by the backing of the government.
Hence, this explains why when the Federal Reserve increases rates, the stock market can experience a contraction. A thing to keep in mind is the current rate is 2.25% and the United States has had an average rate of 5.67% from 1971 to 2019. While rates reached a high of in 1980 and a low of 0.25% in December of 2008.
Now, with regards to my portfolio, I’m intending to significantly add to my long position in Apple (APPL). Starting with Apple, the company has the lowest P/E ratio among the FAANG stocks. Also, when discussing the FAANG stocks, I like to include Microsoft (MFST) so my version, in this instance, can be called the FAANGM stocks. Hence, below I’ve listed the individual P/E ratios of the companies within the FAANGM.
- Facebook (FB) P/E: 26.36
- Amazon (AMZN) P/E: 74.05
- Apple (APPL) P/E: 14.72
- Netflix (NFLX) P/E: 122.57
- Alphabet (GOOGL) P/E: 27.75
- Microsoft (MFST) P/E: 27.50
At $175.07 I find myself close to pulling the trigger and loading up on shares considering I have about $400,000 to $600,000 to utilize depending on how aggressive I want to invest. Understanbly there are a multitude of factors that have led to Apple’s price decrease. Trade wars, potential production issues and the smartphone sales all have have contributed, but I’m a firm believer in the company and the recent growth in their services. One thing to note before ending the article, since 2017, 5 highly publicized IPOs have been Uber, Lyft, Pinterest, Spotify and Snapchat. What is one thing they all have in common? They are all applications within the app store and are used within the Apple product network through Iphones, Tablets, etc. When we think of innovation in the terms of Apple, one immediately thinks of revolutionary products (i.e. the Iphone) but what people are failing to recognize is the second wave of innovation is coming from within their services network. Uber, Lyft, Pinterest, Spotify and Snapchat all need the Iphone to market their services and compete for Apple user’s attention and dollars. What I se here also developing is a services moat.
When I previously wrote about Twitch I wrote “While inherent risk always lies within the video game creators (similar to fashion or retail their franchises can simply fall out of popularity) Twitch seems to have a completely different model in which they aren’t subjected to this. For example, if the current popular game Fortnite becomes a thing of the past Epic Games maybe struggle to replace their primary franchise/money maker, while all Twitch has to do is shift it’s live streaming focus to another popular game/platform.” To bring this back to Apple, Uber or Snapchat can go out of favor and whenever company goes “cold” its replaced by one that’s “hot” or “trendy”. As for the services offered within the app store, some will disappear and new services will come to prominence, but the moat for Apple is there because they have very little skin in the “hot” and “cold” game. They are profiting from other companies innovation within their network and this will in-turn drive demand and need for Apple’s individual products (think Iphone, Computer, Tablet, etc).