@theMarket: A Churn at the Top
It was a sleepy week in the markets for the major averages. Stocks flirted with the old highs, only to fall back by the end of the week. Energy and a few meme stocks occupied most of the attention.
Crude oil spiked higher, nearing almost $70 a barrel (bbl.), pulling energy stocks along with it. Energy traders were heartened by the latest OPEC meeting. The cartel expects demand to outstrip supply by more than a million barrels a day for the foreseeable future. As a result, the members intend to gradually increase production as the global economy gathers steam. Most analysts expect oil to breach $70/bbl. before taking a break.
Certain stocks such as AMC and GameStop, which have been dubbed "meme" stocks by the Reddit crowd of retail traders, had an unbelievable week of gains. AMC, the nation's largest theater chain, for example, saw its stock gain by more than 100 percent in one day. The price rise finally slowed and then reversed after the company announced two consecutive stock offerings over three days.
There is no fundamental reason to justify this kind of price movements. I witnessed the same thing during the Dot.Com boom (and bust) back in the beginning of this century. For those who can ride the bull, I applaud you. I just hope you are lucky enough to exit before you get trampled. Buyers beware.
Investors are also watching the infrastructure negotiations between the two political parties. The horse trading is getting intense. Reports that President Biden might be willing to revise his proposal to increase the corporate tax rate to 28 percent from 21 percent cheered markets. That tax hike has been a major roadblock in winning Republican support for his infrastructure plan.
The Washington Post reported that Biden might consider a minimum corporate tax rate of 15 percent instead. On the surface, that might seem to be a tax cut from the present 21 percent rate. However, few corporations pay the going rate (although politicians like to pretend they do). The actual tax, after all the credits and loopholes in the tax law, usually results in a payment that is a substantial discount to the stated tax rate. Some large corporations pay no tax at all.
Another indication that the U.S. Central Bank sees further signs of economic recovery is that the Fed announced it was preparing to sell its $13 billion corporate bond and ETF portfolio (called the Secondary Market Corporate Credit facility, which it established during the pandemic). Officials made it clear that this was a separate move and should not be considered as a move toward tightening monetary policy.
May's Non-Farm Payroll employment report for May 2021, which was announced on June 4, was the second monthly disappointment in a row. New hires came in at 559,000 jobs. That was far lower than the 675,000 expected, but bad news proved to be good news for the financial markets. Stocks rallied since markets are keenly focused on the "tapering" conversation.
Some Federal Reserve Bank members continue to talk openly about the need to start tapering purchases of fixed income assets. Yet, other "doves" on the FOMC board remain convinced that we need several more months of data before beginning that process. The weak employment numbers give credence to those Fed officials who want to go slow.
Continued, easy monetary policy means interest rates should remain low, which is good for equity assets. And so the stock market rallied on the Non-Farm Payroll "bad" news. At this point, traders are expecting to hear more about tapering from Fed officials after their mid-June FOMC meeting with a possible announcement on when tapering will begin around the Fed's annual Jackson Hole conference in August.
Equity markets, I believe, will continue to be a battle between bulls and bears. While summers are usually a slow period in the markets, I suspect this year we could see further turbulence and possibly further gains. That could keep the pros close to the terminals, since we are quite close to historical highs on the S&P 500 Index. A break above them (at 4,238) would give the bulls clear sailing to 4,300. The question is what new piece of news could trigger that breakout?
The crypto currency market, on the other hand, remains subdued. Bitcoin continues to trade in a range between $33,500-$38,000. Technicians seem to be biding their time before making a move. Many believe Bitcoin must either break decisively below $33,000 to sell it, or above $40,000 for new purchases.
In the commodities corner, copper, gold, and silver took it on the chin this week after the U.S. dollar bounced off three-week lows, while oil continued to rally. Volatility like this is the name of the game when investing in crypto currencies, commodities, and commodity stocks. There is a saying "If you can't stand the heat, get out of the kitchen," so invest accordingly.
@theMarket: Inflation Fears Weigh on Investors
Most stocks took it on the chin earlier this week. Technology shares lead the rout, but it didn't take long before just about everything else followed tech lower. By the end of the week, it was as if nothing had happened. That's called "chop." Get used to it.
The Consumer Price Index (CPI), which investors use to gauge future inflation, took the lion's share of the blame for the downdraft in equities. Economists had warned that we should expect a higher monthly reading (0.2 percent) for April, but the data came in at 0.8 percent. That computes to a 4.2 percent price gain year-over-year and was almost triple the rate that anyone had expected.
The market reaction was swift. Interest rates spiked higher along with the dollar, while equities dropped. The carnage continued for three straight days, taking the S&P 500 Index down 4.2 percent from its high of 4,238. Traders waited until the index hit its 50-day moving average at 4,056 before buying the dip. A relief rally on Thursday and Friday repaired about half the damage.
The CPI shock was not a one-off, statistical aberration, however. April's Producer Price Index (PPI) was also released this week, showing a jump of 6.2 percent versus a year ago. That was the largest increase since the Bureau of Labor Statistics started tracking the data in 2010. The monthly increase of 0.6 percent was twice the expected gain.
Economists were quick to explain that the numbers were not as bad as they appeared, since a year ago the economy was in a free fall. Prices were at their lows during the pandemic, so comparisons were bound to be stronger than expected and will continue to be so for the next several months. They have a point and investors seemingly calmed down a bit.
Over the past few months, the fear of uncontrolled future inflation, fueled by governmental stimulus and a growing economy, has been a primary concern among traders. There is presently a tug of war between the Fed, which believes that this spike in inflation will be transitory at best, and the inflation bears who argue that there is no such thing as transitory.
This week, the market algo computers sold stocks on the CPI news and it took cooler heads a day or so to prevail largely on the news that the Center for Disease Control (CDC) announced they were lifting inside mask restrictions for those who have been vaccinated. That revived the bulls, who piled into the re-opening trade once again
I had written last week that the best investors could expect from the markets over the next few weeks would be marching in place. I warned that there was also a real possibility we could experience a 5-10 percent decline in the S&P 500 Index and worse in the NASDAQ. Well, this week we lost almost 5 percent in the benchmark S&P 500 and closer to 10 percent in a lot of technology stocks. Some of those high-flying, next generation stocks with no earnings or sales have experienced a 30-50 percent pull back in the last few weeks. Some may be tempted to get back into these names but now is not the time, in my opinion. Better to focus on value and cyclical stocks that have real earnings, dividends and a strong balance sheet.
It is after all, the month of May, and so far it has lived up to the admonition to "sell in May." It is quite possible that we will see the same kind of chop in the markets for a while. If so, I advise readers to sit on your hands, do nothing and ignore the noise. Otherwise, it could be you who ends up on the chopping block.
@theMarket: Stocks Make New Highs
It has been the best quarterly earnings season in a long time. More than 87 percent of companies that have reported thus far have beat earnings estimates. That is a record and investors celebrated.
Last week, I mentioned that this earnings season has been a classic example of a sell-on-the-news. It has been especially so for companies in the technology sector, but not so much for investments in other areas. What, you might ask, does this say about the overall markets?
The most bullish interpretation is that we will continue to move higher making new highs after new highs. The Dow Jones Industrial Average made yet another new high yesterday, as did the S&P 500 Index. The NASDAQ is still off by 4 percent from its highs and the small cap Russell 2000 Index is off by 6 percent.
However, for the year thus far all the indexes have positive gains. The S&P at 12 percent is about ties with the Dow, while the small cap Russell and the technology-heavy NASDAQ are lagging. I have been warning investors since the beginning of the year that technology, especially the stay-at-home stocks, would be underperformers.
As we enter the second week of May, with the markets at, or close to, all-time highs, investors need to ask how much of the present macroeconomic data is already reflected in the price levels of the stock market. We know that coronavirus cases are falling and will probably fall further. We also know that this quarter and next will see economic growth spurt higher, while unemployment drops. I feel it would be safe to assume that the market has already discounted some of those future expectations.
However, don't think that Wall Street economists get it right all the time. Take April's unemployment report. Forecasts were for the economy to gain one million jobs last month. Instead, only 266,000 jobs were added. That was the largest miss since 1998. It immediately cast doubt on the timetable of economic recovery.
Expectations are that the economy is going to roar back, and with it corporate hiring plans. Friday's report, if anything, might reduce some of the more bullish enthusiasm of some financial analysts. That is a good thing, in my opinion.
The prospect for higher inflation is still a question mark, as is the future course of interest rates. Those two variables are interconnected and will occupy our attention for the foreseeable future. Sectors that benefit from inflation, like commodities, are outperforming. I expect they will continue to do so as the economy recovers. So-called “value' areas like industrials, transportation, and materials, as well as financials, have also done well and should also continue to gain, even if interest rates move higher.
The sectors that are hurt by inflation or higher interest rates, however, should underperform. The result could be a bifurcated market, something I believe we are witnessing at times right now. I am expecting markets to climb a little higher. My target for the S&P 500 Index is between 4,220 and 4,270. At this rate, we should hit my target by next week.
At that point, those invested in the three main indexes, you could see markets simply pause in the weeks ahead and trade in a range. That would be my most bullish scenario. The bearish story would be a classic May sell-off of possibly 5-10 percent. If that were to occur, the good news would be that the stronger sectors might mitigate some of the downside potential in the weaker areas.
I will be watching the transportation and energy sectors for clues. Those two areas should continue to gain if investors believe the re-opening trade is still intact. Weakness might indicate economic prospects have been fully discounted, in which case, the markets should follow their lead downward. Stay tuned and keep reading.
@theMarket: Fed Signals Equities 'All Clear' But Markets Don't Care
Investors were bolstered by the Fed's message this week. Low interest rates and monetary stimulus will remain pillars of the nation's economic recovery for as long as it takes. Investors were comforted, but not enough to materially move stocks higher.
It was indicative that despite bullish news on a variety of fronts, investors ignored the good and focused on the negatives. First quarter earnings results, for example, have been better than good, but not enough to satisfy the bulls. Apple smashed earnings estimates, sending its stock price higher in after-hours trade, but the next day it finished down. It has been the same story for many of the market's winners. What this tells me is that a lot of the good news in the market and in individual stocks may already be priced in.
Turning to the pandemic, the words we have all been waiting for "we have turned the corner," were spoken this week by President Biden in his first address to Congress. That should have sent markets shooting up, and it did for a moment or two. But investors choose instead to fret about the skyrocketing coronavirus cases in Brazil and India and what damage that might do to global trade.
On the economic front, this week's unemployment claims reached another pandemic-era low (553,000 claims), while first quarter GDP came in at a robust 6.4 percent. Many economists believe the numbers are going to get even better from here. The data was greeted with a mild yawn and little response other than to push the yield on the U.S. Ten-Year Treasury bond higher.
In the background, investors are keeping an eye on what most on Wall Street are calling President Biden's progressive agenda. The price tag on all this intended government spending (if passed) now totals in excess of $6 trillion. In order to pay for it, the president is seeking to raise the corporate tax rate, plus increase the income tax rate on the top 1 percent of taxpayers. In addition, the capital gains tax for millionaires would practically double in order to equalize the taxes on investment income and the tax rate for ordinary income. In another blow to the wealthy, the president would get rid of the so-called step-up in basis at death for any gains of more than $1 million.
Higher taxes are almost never good news for financial markets and might provide some of the concern that seems to have soured investors' moods. The fact that most Americans would not be hurt by Biden's tax increases may be tempering the potential damage of these tax initiatives as there is the plan itself.
If passed, investors know there could be an awful lot of fiscal stimulus on the way. Some economists are now comparing President Biden's plan to FDR's social programs during the Depression. If that were the case, a look at history would indicate a great leap forward in economic growth.
The three major indexes responded to all this good news, making new highs as the week progressed, but the bulls just couldn't keep up the pace. There was an increasing churn to the markets with individual stocks getting clobbered, despite favorable news across the board.
This is usually a precursor to some further consolidation that may be in store for us. An increasing number of Wall Street strategists have been sounding the alarm, predicting a 5-10 percent pullback at any time. Of course, several of them have been saying that for weeks or months and it has not occurred.
My own guess is that we spend the next few days digesting more earnings results, and then take a run at 4,240-4,280 level on the S&P 500 Index. At that point, let's see where we are. If there isn't still enough steam to move higher, than the ‘sell in May and go away' advice we hear every year might be in the cards. And May is only a day away.
@theMarket: Stocks Hit With Possible Tax Hike
It was a losing week for stocks. Most of the blame can be pinned on a proposal by the Biden administration to double the capital gains tax on investments. It is not official yet, but investors are counting on an announcement next week.
Before you hit the sell button on all those huge capital gains you have accumulated over the last few years, know the facts. Right now there aren't any. What we do know is that Joe Biden ran his winning presidential campaign on increasing taxes on the rich and on corporations. He plans to do just that, so it should not be a surprise to investors.
This proposal, if true, would impact the top 0.3 percent of Americans. For those earning $1 million a year or more, he wants to increase the capital gains tax rate from 20 percent to 39.6 percent. That is on top of the 3.8 percent tax on investment income that presently funds Obamacare. If you add in state taxes, the overall capital gains tax would be as high as 52.22 percent for New Yorkers and even higher for California residents (56.7 percent).
That would clearly be a steep increase and one that would impact all the stock market, at least temporarily. Just think of the gains some have accrued in the FANG stocks over the past few years. Many high-growth stocks are in the technology space and wealthy investors may want to cash in some of their chips if they truly believe the capital gains proposal would soon be the law of the land.
Wall Street pundits, while concerned, are attempting to downplay the suggested tax risk to investors. The level of increase, they say, is simply an opening gambit, a trial balloon, meant to be negotiated downward, if it were to pass at all. The slim majority of Democrats in Congress might make it impossible to get any capital gains tax change to get through. And, even so, the timing of any tax hike is also in question. Would it be effective this year or next?
Market participants are also anxiously watching the global COVID-19 case levels. Countries such as India and Japan are seeing coronavirus cases skyrocket. Here in the U.S., spring coronavirus cases are surging. Back in February, during the last surge, the U.S. was averaging 65,686 new COVID-19 cases a day. Fast forward to today, and we are averaging 64,814 new cases daily. Some states, like Michigan, are breaking all-time records in new cases.
You would think that doubling the number of vaccinated Americans would have at least made a dent in the rate of new cases, but at best, all it has done is kept the level of new cases around 65,000 a day. What may be even more concerning is that a new COVID variant has been detected by scientists at the Texas A&M lab that show signs of antibody resistance and more severe illness among young people.
The more contagious variants of COVID-19, which have become the dominant strains within the U.S., seem to be the culprit in this case and in the high level of new cases, according to medical experts. However, the good news is that the present administration seems to be doing all it can to get more people vaccinated, provide additional stimulus to the economy, and expand global trade and relations.
All this news, as you can imagine, is having an impact on the financial markets. The three averages have pulled back a little this week, but the real story is in the Bitcoin trade. I warned readers last Friday, cryptocurrencies (Bitcoin specifically), were ripe for a correction. Saturday, Bitcoin dropped 15 percent and by the end of this week the price of Bitcoin was below $50,000. Other popular coins such as Ethereum and Litecoin have also declined. Some analysts are expecting as much as a 50 percent pullback in Bitcoin (to $30,000) before the correction is over.
It does appear that momentum is stalling in this space. As I have written in the past, cryptocurrencies are considered speculative assets and not currencies, according to The U.S. Federal Reserve Bank, and other central banks. As such, investing in this area is fraught with risk, no matter how convinced you are in its viability in the long-term. Only those with a strong stomach and staying power should be involved in this space.
As for the equity markets, despite a 1-2 percent decline, stocks are in a trading range. As we consolidate recent gains, I expect continued daily rotations between sectors and asset classes. I still think stocks will continue higher in the weeks ahead, but so will volatility.