After the Federal Reserve's FOMC meeting concluded on Wednesday, the market rallied off from earlier lows, sending a positive sentiment that everything was going to be good again. Even stock futures overnight on Wednesday, into Thursday morning, primed everyone to think we were heading for new highs on every front. However, when the tape started to roll on Thursday, a very ugly sell off unwounded, particularly in the Nasdaq index which holds lots of high-multiple, no-earnings concept stocks. We usually use Cathy Wood's flagship ETF ARK Holdings (ARKK) as an example for the high octane growth names, because most of the stocks that she owns have no earnings and trade at multiples of sales. ARKK was down 4% on Thursday, down almost 50% from its 52-week high. Meanwhile, low-multiple, real-earnings, real-product stocks performed relatively well. The financial sector (XLF) was up 1.2%. Healthcare (XLV) was up 0.6%. A Tesla which trades at a 100x forward multiple was down 5%, while a Ford which trades at a 10x forward multiple was up 0.8% (example of high valuation vs low valuation). 

Why am I bringing up the divergence of action? I want to talk about the playbook for 2022. What will work? What will not work? In the first post of the series of educational content, I discussed the concept of thematic investing, in which I told you to identify themes that you believe will work in the future. By now, you may have identified multiple themes, maybe too many. Today, I want to tell you which themes you need to cross out from that list, because they simply will not work for 2022. Selecting themes to invest in is one step, but choosing when to invest, what company within the theme to invest, is another problem. Let's tackle that problem today. 

Thursday was Day 1 of "Don't Fight The Fed" sell-off. Thursday was also Day 2 of "Santa Claus" rally. The cheap valuation ones participated in the Santa Claus Rally, while the expensive ones got hammered. Martin Zweig, a legendary Wall Street investor, author of the book "Winning On Wall Street" has two infamous sayings: "Don't Fight The Fed" (Fed being Federal Reserve, the institution governing monetary policy) and "Don't Fight The Tape." 

Back in the days, Zweig spent a tremendous amount of time talking about the interplay between the Federal Reserve, liquidity and the stock market. One simple rule you need to know: "More stocks go up when the Fed is easing. Fewer go up when the Fed is tightening" (FYI: the Fed is tightening). So, don't fight the Fed.

You also don't want to fight the tape. I have talked about a Santa Claus rally multiple times, and I believe we're starting to see that right now, with the financial stocks and healthcare stocks starting to rally. 

Putting the two together, it must mean that only some stocks will go up, not all. You have to be picky stock-pickers. What I want to do here is go over different baskets of stocks and tell you which will and which will not work.

• Cyclical stocks (sensitive to economic cycle - go higher when economy is hot, go down when economy cools): you may think that cyclical stocks would go down when interest rate goes up, because raising of interest rates is equivalent to tapping the brake on the economy. However, historically, cyclicals do well in the early days of rate hikes, because if the raise is gradual and slow, the economy is not much affected. You do have to be careful though, because there will be an eventual time when the interest rate goes too high and that will finally take down the economy, hence the cyclicals. But we're years away from there.

• No-earnings stocks: what really gets hammered when the Fed tightens are companies with no earnings. I want you to imagine that market analysts, money managers and market players have a playbook their office that is to be opened when the Fed raises interest rates. The time to open is now, and what is said in there? "Sell the most expensive stocks." That's it. If you have a tech stock that sells at 30x sales, when the market sells at 20x earnings, that stock has got to go, no matter your "thematic thesis." When money was essentially at zero cost last year, market was willing to pay up for these no-earnings stocks. But once the capital starts getting expensive (higher interest rates), there's no room for those stocks.

• Housing stocks: traditionally, housing-related stocks do not do well in tightening monetary policy. Raising of interest rates will make it more expensive for homebuyers to get loans, thus driving down demands, ultimately driving down house prices. That is why our investment portfolio does not own any housing stocks.

• High-multiple retail stocks: these are companies like Gamestop, AMC, Best Buy, ... that are in the retail business. Higher interest rates raises their borrowing costs. Also, higher cost of money drives down demands. Lastly, any Covid-related headwinds could take these names down in seconds. Try to stay away.

So the window of what could work for 2022 is closing out on the types mentioned above. Now let's talk about names that are going to work:

• Financials: any reasonably valued, true financial stock could work for 2022. We own Wells Fargo, JP Morgan and Morgan Stanley. Wells Fargo will work because they make money on the spread between borrowing money from the government for the long term and then lending it to consumers for the short term. When the short-term rate goes higher, more than the long-term rate, the spread gets bigger and that's what allows Wells Fargo to make money (see recent WFC analysis). Morgan Stanley (MS) on the other hand has a different business model that Wells Fargo and JP Morgan. While Wells Fargo has credit risks (people borrowing but not able to pay back), Morgan Stanley is a gigantic money-generating machine, charging rich people a stable cost for managing their wealth. 

• Consumer Staples: these are companies that sell high-demand products regardless of the economic cycle. Booming or slowing economy, everyone needs toothbrush, so Colgate (CL) is a good name to have (up 1.4% on Thursday). Everyone goes to Walmart for grocery no matter pandemic or not, so own Walmart. 

• Healthcare: very similar theme as the consumer staples, healthcare companies, products and services are needed no matter what. You have my endorsement to pick any pharmaceutical companies whose stocks are sold less than 20x forward earnings. We own (and are up big) on Eli Lilly and Pfizer, yet we don't see us selling them any time soon. 

The bottom line: My opinion doesn't matter, Wall Street has a playbook, and you will get hurt trying to go against it. The playbook right now is sell high-multiple, no-earnings, concept stocks, and buy low-multiple stocks that do well in a high interest rate environment. Don't fight the Fed, and don't fight the tape.