Well, we finally got it. We got our first rate hike, Jerome Powell, the Fed chair. Just announced a 25 basis point rate hike, which against a lot of people's assumptions, sent the market flying much higher, much higher. In fact, it's up three point, seven, seven percent for the NASDAQ three point, seven, seven percent, the S&P 500 is up 2.2 4 percent today and even the Dow Jones was up one point five five percent, but the type of companies that you would assume
would be hurt the most. By interest rates going up. We're the ones that went up the most today and this is what I want to make sense of why did the market move this way. In fact, if we even extrapolate this further and we go down the or up the risk curve to the more risky companies like the ones held in the story fund. These companies did even better. Today, if I go to the one day, we're up five point three, eight percent that is 5000, $683. Just today in one day so we're
still in the red overall. It's been a rough couple of Months. But this is a very significant day and in this video we're going to make sense of all of this. We're going to go over what Jerome Powell said what his thoughts are on the chance of us going into recession, how many rate hikes are planned in the future, how? This may affect the equity markets and my thoughts, and how it will affect it, we're going to go over all of it. Now, let's start off with his
major announcement. The big announcement today was at drone, pal. Raised, the interest rates by a quarter of a percentage. The federal fund rate is the rate at which banks can borrow Borrow from each other. So when that goes up, the cost of capital goes up, meaning any business, or any individual that wants a loan for anything, pays a higher price for that loan. They pay a higher interest rate, this slows down the economy. It is not accommodating policy.
It is policy that's unaccommodating and it makes the economy slowed which should have the effect of combating inflation. So, the reason that drone pal is Raising interest rates to begin with is because the economy is incredibly strong right now. But inflation is I so the inflation needs to come down and he thinks it interest rates will help accomplish that and the economy also can manage the
interest rates coming down. But having said that let's go ahead and give this some historical context because this may seem like a big deal. Our first interest rate hike in reality, this is a puny interest rate hike. We are right now effectively at 0% interest rate. So money is essentially as free as it will ever get in the the u.s. borrowing is as cheap as it will get.
And what Jerome Powell is doing, is bumping this up to 25 basis points which is a quarter of a percentage that puts us right there in December of 2015. That's how high the interest rates are historically. Look at that little dot on the chart. Does that look like it's historically high? No this is barely anything. This is barely above zero and if we even zoom out further you can see how how puny this looks over. All that little dot right there by 2.
I'm 15 is where the interest rates are being moved after today. Now, having said that the markets have been used to this low interest rate environment. So a lot of the expansion from 2009 all the way to 2016 was in a very low interest rate environment and that causes an economic, boom, but we didn't have inflation during that time period. So the FED didn't need a raise interest rates. Now, since we have inflation, we
gotta raise interest rates. So the FED is officially raising interest rates by a quarter of a percentage, and they have six. More planned in 2022. So there is going to be a series of interest rate hikes throughout this year. Now I know whenever you have a series of interest rate hikes the concern becomes for investors is are we going to be
sent into a recession? Because we look at history and many times the FED has to aggressively raised interest rates and not only does that stop inflation by slowing the economy. Sometimes it slows the economy. A little too much sends us into a recession. Not something good for the economy or or investors. Returns. So this was something that was, it was like, the first question asked to drone, pal was, how are you confident that this isn't going to send us into recession?
And this is his response to that question. So, I guess I would start by saying that in my view the probability of a recession. Within the next year is not particularly elevated. And why do I say that aggregate demand is currently strong and most forecast. He says the possibility of a recession is not particularly elevated. That's the opposite of what I've been reading by a lot of analysts and forecasters but we have the Fed chair that has all the data.
He has so many economists and people working for them and the indicators they show again he's reiterating, it is not elevated we do. Have an elevated chance of recession, the opposite thing. You probably have heard from all the YouTube videos and articles that you've been reading over the past couple of weeks. But he goes on to explain why he be? Is it this way?
Master is expected to remain. So, if you look at the labor market, also very strong, conditions are tight, and payroll job growth is continuing very high levels, household, and business balance sheets are strong. And so, all signs are that this is a strong balance sheet, labor participation, rate payrolls. And companies every indicator.
They look at for a strong economy shows that the economy right now is strong on economy, indeed one that will be able to flourish not to say withstand, but certainly flourish as well in the face of less accommodative monetary policy. So I guess that's how I would say I'm looking at that. Of course, the objective is to achieve price stability, while also sustaining a strong labor market and that, that is our overall objective. Active.
But we do feel the economy is very strong and well, positioned to withstand tighter monetary policy. So he says, again there, that the economy is very strong, it's able to not only handle and take in these new interest rate hikes, but it's able to flourish through it to grow out a quick
speed. In fact, he goes on to say that the rate of growth expected the GDP growth of the US economy throughout this year is expected to be two point eight percent which is very high growth in historical context, that's one of the better years of the past. Last 10 years of expansion. So drone Palace says, not only should the economy be able to handle these interest rate hikes, but it should be able to flourish through them, not just handle them, but flourish
through them. And in my opinion, I think that's one of the that's got to be one of the biggest things. The best things to investors ears is hearing drone, Pals say, look we're not at a heightened chance of recession. A lot of that is like investors panicking and that type of thing and we look at all these indicators and we do not believe Eve that this is going to cause a recession. I have to believe that that's a big part of why the stock market
went up today. Simply the confidence in the Fed chair that he's not going to send us into recession. Now, you may think that he's wrong that they don't have. It figured out, it's going to cause a recession but still they are looking at all those indicators. And in my opinion I've been saying this for a while. I think markets are always predicting recessions. I think there's always a lot of Hysteria and concerns but going into like a 2008 recession. I think is just unlikely.
We had a lot of events happen than that were particularly and uniquely horrible. And I don't see those type of things unfolding unless there's something totally unknown. So I kind of agree with your own pal here. If I had to take a side between all the, all the people that are screaming Doom and Gloom and him, predicting that we might get through this without going into recession. I think there's a really decent chance of that.
The other big thing that I want to highlight, why would stocks go up so much today? We have been hearing for After month, that interest rates going up, is bad for stocks, because it raises the 10-year treasury, it makes bonds more appealing and it makes it. So there's other options to invest in outside a stocks. So, why are stocks going up today? Well, this is the reason you
don't try to time the market. It is very difficult to figure out what is priced in currently and what is not priced in. We've been told that interest rates are coming for months and months and months and the devil that you don't know, Is worse than the devil you do know. Now that we actually have a clear consistent plan from the Fed chair. We have Clarity to interest rates being risen right now. We have Clarity to how the economy stands right now.
We have a path going forward of interest rates with transparency and Clarity investors like that before today it was a lot of just predictions and unknowns and not too much transparency to what's actually going to happen and as you might notice investors hate unknowns, they hate unpredictability. Any added level of clarity and consistency. Helps markets. Move up.
So I think a lot of the move up today was also related to investors finally getting over all the predictions in the unknowns and finally having it happen. Finally having interest rates. Go up. We're getting to this phase and knowing that it might not actually be the end of the world, that's at least my prediction. So determining, why markets move up as a little bit of a guessing game.
But if I had to guess those would be the reasons why we have confidence that were not going to be sent into recession. And we have some Nancy and consistency and to what the FED is actually doing. So investors can accurately priced at in. Now, big question for us investors is what happens next as we go throughout this year 2022 and a series of rate hikes what happens to the valuations of our companies. Well we can look at this through
historical context. The first thing is is that the valuations of software companies in particular. Cloud companies has came down dramatically so a lot of the selling is behind us. Take a look at these valuations. Historically, this is the Enterprise Value to next, 12 months Revenue, multiples of SAS companies, and the blue line here is the median valuation. So what we can see is that up until 2020. It was around like a 10 times multiple. Then it went all the way up to
almost a 20 times. Multiple software companies, literally went up almost double in their valuation. Then the selling started to happen late last year and their valuations. Got chopped back down all the way to ten times and now they're actually below 10 times to eight point nine times. So the valuations on the median, not the average, but the median are all the way back to around.
8 times. Next 12 months Revenue, multiple, which historically, speaking is pretty decent, these software companies are at a pretty decent valuation. There are no longer in the stratosphere all the way up next to 20 times. So this is good news for SAS investors. A lot of the crazy high excess and super high multiples is behind us. We're now back to more normalized. Now, this next chart is even more applicable to investors
today. It shows the 10-year treasury in Orange, compared against the SAS index in blue. And so you get an idea of how interest rates affect software companies because if the interest rates go up, so does the 10-year treasury? The yield on the 10-year Treasury and if the yield on the 10-year treasury goes up, it's more attractive to investors. So money is pulled out of the equity markets and into the bond market to buy the 10-year treasury, it just makes sense. Right?
Because Because if the 10-year treasury was yielding like 20% I would probably liquidate my portfolio and by that it's a risk-free 20% but of course right now, the 10-year treasury is only right above 2% so I'm going to stay invested in equities but again the 10-year treasury will go up as interest rates, go up making it more attractive and affecting the pricing of all other Investments.
And this is what it looks like. When you compare that against software companies, what we can see is that there is someone Of an effect. When the 10-year treasury goes up dramatically in a short amount of time, typically, that's led to a little bit of a sell-off in software. Companies, the multiples have contracted when that happens. You can see it right there in 2016. The 10-year treasury went up quite a bit, quite rapidly, and software multiples, contracted over that time period.
You can also see, you know, in 2018, the treasury went up and softer multiples actually expanded but then it continued to go up and they started to contract back. Down. So it's not a perfect correlation. You can see right here, where where the 10-year treasury went down like crazy software
multiples, went up like crazy. So you see the inverse correlation there and just recently you can clearly see that software multiples are Contracting going down like crazy as the 10-year treasury is anticipated to go up, so investors are pricing that out. So when I look over this chart I do see somewhat of an inverse correlation when the 10-year treasury goes up like crazy multiples for software
companies. Down. And we could expect to see that in the future if the inflation just gets out of control and even Rising the interest rate, step-by-step doesn't get inflation under control. And the FED is like, well well dang. We got a rise in interest rates even higher. 3% 4% 5% 6%, they get up to 6% interest rates and the 10-year treasury is you know way higher than its been historically. For the past 10 years I think software company multiples will contract a lot and that scenario.
I could see them going from the eight times. They're at right now all the way down to four but that is a very particular scenario that's under the assumption that inflation never gets under control and the FED has to continually rise interest rates. There's always a chance that inflation does somewhat diffuse over the next couple of years.
The FED does raise interest rates to, like two or three percent, and they keep it there because the economy slows down a bit, inflation comes down and software companies, I think would do fine and that environment. So, a lot of this is kind of like, you know, What path is the economy? Go down. What Pat does interest rates really take? Ultimately, ultimately, all of, that's impossible to predict.
But, right now what we know for certain is that software company valuations are no longer in the crazy category, there are no longer flying up into the Stratosphere.
In every single category of software companies, the high-growth ones, the mid growth ones and the low growth ones their way back to normalize valuations, they're back to where they normally trade at. So, When I look over at my portfolio, to me, this is very bullish news, I look at it and I think that valuations are much better. I think the FED has a clear path to raising interest rates and I think that the chance of going into recession right now, Still
Remains low. So in my opinion, even though I'm down right now, I'm in the red, I'm in the gutter right now, I still think I have a decent chance at this. I look at the S&P 500 and it's winning the race right now, but this has been under a condition of anticipating interest rate, hikes and continue. Contraction and multiples after contraction and multiples, multiples, just keep coming down, and down, and down, and down. It's not the software companies doing poorly.
The companies that I'm investing in across the board are performing their performing, very well. They're growing their earnings are growing, their revenue, they're growing, their free cash flow. They're growing their market share. This is multiple compression and ultimately, at some point, multiple compression will stop. It will it will hit a bottom, will hit the point where the Ian, multiple software companies eventually stops and then it will be reliant on their growth.
And I think that these companies growth will far outpaced the broader market. So, even though we're trailing the S&P 500 right now. I think over the next three or four years, there's a decent chance. We'll climb back up to not only meet it but surpass it. So there's my update for today. I hope you enjoyed this little update. If you like this type of content, you can check out the patron. There's a link in the description below comes with a
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