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This is an abridged conversation from Seeking Alpha’s recent Investing Experts podcasts recorded with JD Henning on April 24, and Chaim Siegel on April 20, 2023.

• 2:00 – JD Henning on upcoming FOMC meeting – will be this be the 3rd rate hike for the year?
• 5:00 – Mega-cap stocks priced to perfection
• 7:10 – Is the VIX broken?
• 11:30 – Chaim Siegel on what inflation is doing and is the Fed going to cause a recession?
• 15:50 – Rate hike expectations
• 19:05 – Tech stocks and AI’s inflection point

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Transcript

Daniel Snyder: I mean, we could talk about the Fed. We could talk about earnings. Let’s actually start with the Fed. I mean, we’ve got the Fed meeting coming up next week. 25 basis points are on the docket. What’s your approach? What are you feeling about this?

JD Henning: Well, I’ve been tracking it closely. This is supposed to be the third rate hike of the year. And that’s what Chairman Powell promised for us last year. So it’ll be interesting if this will be the last rate hike for the year. And typically, and we discuss this a lot in our chat rooms, it’s not the rate hikes that lead to the market correction, but it’s the leveling off period.

And we get a period where they hold it higher for longer that tends to lead to a downturn historically. And this particular series of rate hikes has been the steepest one that we’ve seen since 1977, and it usually doesn’t end very well when the tightening goes on like this for the banks and for lenders and borrowers that really need the cash flow.

So we’re watching a tightening effect happen here and it’s combined with QT, the Quantitative Tightening, it’s making it a little bit challenging for the markets and the money flows. And then one of the third, I would say, the third key element, I watch fund flows very closely. And what we’re seeing is that corporate buybacks are dropping in the sharpest three quarter decline of corporate buybacks since 2008.

So when we see these outflows and these tightenings occurring, it’s giving me some warning signals. And those warning signals are things that I wrote up in the Seeking Alpha competition to sort of guess where the market would end at the end of the year. And I have a target of 30 to 40 for the S&P 500, but I don’t consider myself any great forecaster of the year ahead. There’s just too much that we can’t predict.

So, those are some targets I’m looking for. The main thing that I’m seeing is a distortion this year in the FAANG stocks. And what I mean by that is we’re seeing a very large crowding into, say, the top 5 or the top 10 largest market cap stocks in the S&P 500 Index. And what that does is it gives us a very low VIX Volatility Index and people are saying, I’ve seen a lot of articles out there saying that, “Oh, look, the VIX is broken. It no longer works.”

But what I think is actually happening, and this is my working theory that I kick around with a lot of members in the community, is that this crowding into the largest cap stocks is offsetting a lot of the smaller cap stocks that are hard hit. And we’ve seen, I think, I saw somewhere that the 10 largest NASDAQ stocks have accounted for 88% of the gains in the NASDAQ. And at some point, that could burst. So I’m playing a cautious swings using the momentum gauges this year.

Daniel Snyder: You’re talking about the FAANGs. You’re talking about everybody overcrowding with the flows. It’s earnings season. This is the week. Everybody is looking at the top five. What are you expecting from them?

JD Henning: Well, I can’t predict what the earnings will be or the reactions will be, but the probabilities are pretty high that these stocks are priced to perfection. And when I look at a lot of different indicators, I see these say the five mega caps, the biggest stocks in the S&P, I see them priced to perfection with well above average price-earnings ratios and price to sales ratios. And I think that’s part of a safety trade that I’ve been monitoring for a while.

And what I mean by that is I look at the number of times that the S&P 500 has swung more than 2% in a trading day. And what’s really fascinating is it’s alternating every years in very sizable differences from 2018. And 2018 was the last year we had Quantitative Tightening, and it spiked with a lot of events in that year. And then in 2019, it came down to very low volatility. And then, of course 2020, it spiked again with COVID, and we had a lot of daily swings over 2% on the S&P.

And then again, 2021, it calmed down, it was very low. But 2022 went up to 45 events, over 2%, which was one of the highest volatile years that we’ve had since the financial crisis. And yet, like this is the – my point is that we’re extremely low. We’ve only had two events greater than 2% on the S&P this year. And when – last year, we were having four of these events a month. Here, we are into the fourth month of the year with only two of them.

And the only way I can explain the so-called low volatility even though the market is swinging, is that people are packing. And I say people, it’s hedge funds, investors, retirement funds and institutional investors, are really overcrowding these large FAANG stocks, which keep volatility low and cause people to think that the VIX is dead.

Daniel Snyder: Talking about the VIX, the Volatility Index. A lot of people have been looking at it. It’s been sub-20 for a while now. Most people looked at it as a sell at 20, buy over 30, that was kind of the game plan for last year, if you will, is the VIX broken now? What’s the take here? What do investors not know or think about of the VIX at these moments?

JD Henning: Well, yeah, we touched a little bit on that. I think it’s the overcrowding into some of the biggest FAANG stocks. It’s causing a dampening effect in the VIX, because the VIX is based on derivatives of options of the S&P 500. And close to 25% of the S&P 500 capitalization is found in those five largest stocks. So they can really dampen volatility. And I’m frankly surprised that we’ve only had two moves in the S&P this year greater than 2%. And I think that’s well below average of what I’ve been tracking.

So I expect sometime later in this year that we’re going to see a reversion to the mean where it’s going to pick up and we’re going to see a lot more VIX movement. I don’t think that the VIX trade is done or it’s dead by any means. I also think that it’s probably going to happen around the August timeframe because there’s a lot of things converging. We have the debt ceiling standoff going on. They’re just talking about forecast, I think, someone from Goldman said that the treasury would essentially run out of cash in late August that they would need some sort of agreement for a CR or a budget resolution.

But that also corresponds to the Fed’s target that they – Chairman Powell said in March of last year that they were going to reduce the balance sheet by a $1 trillion. And that was tracking at about, I think, $90 billion a month. The trajectory that they’re on right now is that it would be around the end of August that it hit the $1 trillion balance sheet level, and the Fed hasn’t – it hasn’t pivoted from that.

And I think the banks did see a rescue. I think it was about $400 billion in emergency loans that they could access, but that was mostly to prevent a run on the banks that that consumers knew that they were backed up. But what it – it doesn’t address is the emergency loan program is different than the quantitative tightening program, which is – it’s the open market action for domestic securities.

And I – from all my studies of QT that it’s actually the Fed investing in domestic securities that has a bigger impact on the markets. The emergency loan tends to be more isolated for the banks, and because the Fed is still reducing to a $1 trillion off the balance sheet, I think, that there’s going to be another issue, I say another because this is a similar program as 2018, and then we saw a big drop in Q4. And it wasn’t until December of 2018 that the Fed had to give up entirely on QT, and they cut rates, they stopped tightening, and the markets recovered.

And in that sense we have a similar pattern evolving towards the August inflection point. But the big difference is, of course, inflation, and they keep insisting they’re going to hit their 2% inflation target. And I think that’s debatable. That’s going to be a real challenge because inflation is going to be sticky. It doesn’t come down as quickly as we would like.

From How Investors Should Think About AI, Micron, Tesla And The Fed With Chaim Siegel:

Rena Sherbill: We’ve had some analysts on talking about where they think the Fed is going to go and how they think that’s going to affect the market? How are you looking at that?

Chaim Siegel: Well, I think my job of Fed following is basically Fed bashing, which is isn’t so nice, but they forgive me. It’s part of the business. But I think this recent fed is a little less humble than past feds, and like they’re so sure of themselves and everything they say, but past feds have always said, our estimates are always wrong. And this is our — what we think now, but it – and it can change, and we can be wrong, but this one, this fed is a little less humble, and they follow the markets less. In fact, Kashkari was saying, we’re going to play a game of chicken with the market.

And that’s not the way it’s supposed to be. I think the Fed and the market should work together. In fact, the Fed’s mechanism after following them for 20, 30 years is really just to try to move the market. And so if they can get — if there’s a recession, and they can get the market up, then business leaders will start to think, hey, maybe things are good out there. Maybe we should order more, hire more people, and then it cycles. And if the economy is too hot, then the Fed tries to slow the market, literally. I mean, their main got — it’s the tail wagging the dog. Their main thing is to try to get the market up or they try to get the market down to sway business leader opinion and that cycles things both ways.

So I think it’s this Fed trying to go at odds with the market and not looking at the Fed Funds futures and not respecting that and not respecting what the main market calls are out there. They listen to economists. They have basically been wrong, but they won’t listen to the market, which is very right. And I think any player in the market that tries to arm wrestle the market is going to end up getting run over.

You have to respect markets, you have to respect direction, you have to try to understand what the market is saying even if you disagree with it. The market can be wrong, quote wrong for much longer than people can remain solvent. So you want to try to figure out what the market’s thinking. And I think the Fed’s avoided to do that. So the Fed says they need to be tough, but the Fed Funds futures by the CME is saying that they expect one more rate hike, and then after that a couple of more rate cuts later in the year, which is a little bit strange.

So they’re saying that the Fed’s next hike is too much, basically, and they’re going to need to start cutting after that. So — but that’s like what everybody looks at. I’ll tell you what I look at. And I think this is so key. They’re trying to quell inflation or slow it down. But really the stock market is also based on prices. And so inflation is also good for the stock market. So it’s not just in isolation, is the Fed going to raise or lower. It’s what’s inflation doing? And is the Fed going to cause a recession?

If the Fed is not going to cause a hard recession, then the market can hold up. And so far, most of the bears, which has been both, most of the market have been wrong saying that there’s going to be a deep recession. So far there hasn’t. I mean, I was showing subscribers from the end of last year, and it was when I started getting bullish. I was bearish last year. I just pointed out to them that jobless claims are strong, GDP keeps printing positive numbers like a positive two and three, I said that’s not a recession. Recession is negative numbers. So nobody can tell me that we’re in a recession or we’re going into a recession until you start seeing negative prints. Then maybe I buy into it.

So I just thought everybody was off base. And so if the Fed isn’t going to cause a major recession, then the market’s okay. And if the Fed allows inflation to run, that’s not a bad thing for the market, the market’s prices. So if inflation and prices run, that really is good for stock market and Bitcoin and maybe oil or whatever it is. So I think everything needs to be in judged relatively, and not just in isolation, like the media wants you to focus on.

RS: So what do you think that means in terms of the rate cuts throughout the year? Do you feel like they’re going to keep their word?

CS: So while the Fed has not admitted to wanting to pivot and wanting to cut rates, but if — I mean, there was this period of two weeks where Fed Chair Powell went from like, expecting 25 basis points, expecting 50 basis points, expecting 0 basis points, expecting 25 basis points, and it just made the market nuts and it’s – it caused a couple of bank failures.

When he said he expected 50 basis point raise a couple of days later, you had some bank failures. So I don’t think they have a really good grasp of how powerful they are right now, and how — a little bit fragile the market is. So I think — and they even are now talking aggressively even after we just had a mini bank crisis that they’re talking about, no, it’s passed and everything’s fine, where Warren Buffett says, no, it’s not fine. There’s more risk, there’s more bank risk out there.

So this all goes into my thinking that the Fed’s not humble enough. They’re not listening enough. And so – and I’ve called this out. Last year, I said, when the Fed was talking, inflation was transitory and they weren’t raising rates. And they said, no way, no, how, we’re not thinking about, thinking about, thinking about, thinking about raising rates. And I said they’re going to raise rates hard, I told subscribers, and sure enough, they did in a very fast way.

Now I think it could be the opposite. But whatever it is, I mean, that’s one side is called predict the other side is react. So whatever it is, I think, they’re too chicken to do anything too strong. And if they’re too chicken to do anything too strong, which has been the case, then meaning like to – they have no problem to cause growth. They don’t mind being aggressive for that. But to close a recession, I don’t think they’re confident enough or willing enough to close a recession. They’re too tied in with the government and Biden, and even though they’re supposed to be independent.

And I think that they’ll let inflation run, which is — meaning it’ll be always a little too high. But that’s fine for markets. And so as long as they’re not being aggressive, I think, the market is showing very soft action. The economy’s holding up. There’s still a ton of bears out there. And when you have that combination, it’s good. And I think there’s also a chance of disinflation that they’re just not catching on to, just didn’t show up in the numbers fully yet. But if you look at the ISM survey — services, which they claimed they were so keyed in on. Services ISM has started to slow and they didn’t say anything about that. And that’s two-thirds of the economy is services.

So I mean, I’ve been telling subscribers that there could be a potential Goldilocks, which was a term in the 90s, when you had growth and low inflation and productivity. I said there’s a shot at that. And the data points slowly, slowly, slowly are leading to that, where growth is holding up. Inflation is slowly coming down. And if the Fed is not going to get in the way, which I think — so I don’t think they are, then, I’m – I’ve been bullish this year. I continue to be bullish.

RS: And what about stocks in the tech sector? Anything else that investors would be wise to be looking at or thinking about there?

CS: I just upgraded NVIDIA (NVDA). And I really — I was thinking out loud to subscribers. The day before I upgraded, I was like this AI story. It might be some hype. But I don’t think the hype is really in the market yet. And I said, if can really be like the Internet story of the 90s, a dotcom story of the 90s.

So – and then beginning of that story, it really helped the idea of productivity, and there was benefits in productivity, meaning you could get more labor at a cheaper cost and you can produce more at cheaper cost and that helps inflation. It’s really – productivity is part of the Goldilocks that drove the markets in the 90s. And so AI is one of those potential game changers. Right now, I don’t think anybody really knows the potential of it or the dangers of it, or maybe they do know, but I don’t think it’s really in its early, early innings.

And so I think if there’s an AI productivity stock market boom story, like, you had in dotcom, and I very easily can see how that can materialize over the next 6 to 9, 12 months. And it could be more – it could be a broader base. Everybody is saying we’re doing AI, right, and we’re not there yet. And NVIDIA is at the center of that. And they said, and it’s one of my favorite words in the industry for 20, 30 years is when you hear a company say inflection point, and companies are a little odd to me on that. They know that’s my favorite word. So they try to say it, right?

Chaim’s going to like it if I say inflection. So the CEO said it, AI is at an inflection for them. So he knew he’d gets to me and be like he would like that, but that’s I believe him that AI is obviously at an inflection. And I think it’s not so big in a lot of companies numbers, but it will be bigger. So NVIDIA has, I think, been an AI leader. They’ve been talking about AI for years. And they had a trip up with their gaming business in last quarter. But they’ve said very good things about their new main business used to be gaming, but their new main businesses is data center, and data center they said, is going to accelerate next quarter and accelerate all year. And when you model acceleration on acceleration, you start to get big numbers.

And so I listen to what companies say, and I try to model what they’re saying. And my model gets me to much higher numbers than The Street has. For next year, when you take their biggest business that’s accelerating, I mean, look at that in relation to and look at the stock price, it’s going up, Tesla (TSLA) is going down. Their main business is decelerating and NVIDIA’s main business is accelerating.

And so I try to gear — I don’t try to, I think it’s my nature, but my service is geared for beginners and pros, because pros will respect what I just said, and beginners will learn a lot to see. Wait it’s not so difficult to try to pick good stocks, because you just have to say, what’s their main business or what’s the main business or two? And what percentage of it is set up the company’s revenues and margins? And is it accelerating or decelerating?

And my customers and subscribers have seen that when I catch a company that’s slowing their revenue growth, then I say, even though stocks going up. I say, you got to watch out and sure enough, because they’re slowing, then there’s a problem next quarter with earnings or something wasn’t quite right, and the stock starts trending down.

So NVIDIA is the opposite of that, that AI I think, is early on and data center, I think was already accelerating for them. And AI is going to just be like added growth, growth points on that main business.