The performance of FANG stocks this year could shed some light on the overall stock market’s recent volatility. In the chart below, we show the average performance for the FANG stocks (Facebook, Apple, Amazon, Netflix, and Alphabet, formerly Google) against the yield on the 10-year Treasury note. You can see that for the first 4-5 months of the year, the FANG stocks went up when interest rates when up, and vice versa. The rationale for the close correlation was fairly easy to comprehend: rising interest rates were a signal that the economy was strengthening, and better economic growth is good for stocks. Furthermore, when economic growth accelerates, investors want to own the stocks with the most octane, and those are clearly the FANG stocks.
In late May, though, this relationship started to break down. Interest rates pulled back, but the FANG stocks just kept rising. This too made some sense. We had received news that the economy grew at a very strong clip in the second quarter, and expectations were that the strength would continue for a bit. At the same time, we also received some data that suggested inflation remained well contained, and therefore the Fed could continue to hike interest rates at a relatively slow pace. What’s not to like? Strong economic growth and low inflation – buy me some more of those high-octane FANG stocks!
In late August, though, interest rates started to rise again as inflation started picking up and the Fed renewed its commitment to removing accommodation (i.e. raising interest rates) so as to avoid an overheating economy. The FANG stocks, generally speaking, took the news in stride. However, the story has changed over the past two weeks. The yield on the 10-year note has risen sharply since September 26, a period during which the average FANG stock dropped about 9% on average. In stark contrast to early in the year, when the FANG stocks had traded in close correlation with interest rates, now the opposite seems to be the case. Why the change?
We think the market is finally sensing that higher interest rates could be a threat to both economic growth and the stock market. Inflation has clearly picked up, and the Fed is showing no signs of bowing to President Trump’s call for a “go slower” approach. Investors are worried that the Fed, armed only with stale data that is only valid on a lagged basis, is not receptive to the notion that higher interest rates and trade-related pressures may already be having a negative impact on the economy. Will the Fed raise rates too much and choke off the growth acceleration that result from the tax cuts and increase in government spending? The odds are clearly rising.