@theMarket: Higher Interest Rates Clobber Stocks
In the grand scheme of things, a small, upward blip in the yield of the U.S. 10-year Treasury bond should be of little concern to equity investors. But sometimes, when the conditions are ripe, even the tiniest spark can cause a conflagration within a speculative stock market.
As readers are aware, interest rates have been trading at historically low levels for some time. The onset of the coronavirus forced our Federal Reserve Bank to pin them even lower. Essentially, it is why the stock market has been having such a great run. Investors have been conditioned to just assume that, if anything, interest rates might trend even lower but not higher. However, during the last few weeks, the yield on the benchmark 10-year U.S. Treasury bond has been moving higher. Since the beginning of the year, it has gained roughly one-half percent. But real interest rates (minus the inflation rate) are still yielding nothing.
In just about every economic recovery, one should expect to see longer-term rates begin to rise somewhat. Economists have been arguing that a moderate rise in this benchmark bond's yield should be good news for the stock market. That may be true, but skittish investors — accustomed to low rates, for longer, and imbued with so much speculative fever — are finding it difficult to accept that concept.
Investors are concerned that all the stimulus that the government has poured into the economy, plus all the trillions of dollars that the Biden Administration is planning in the near future, will spark inflation. That, in turn, could force the Federal Reserve to raise interest rates and tighten monetary policy prematurely.
It doesn't matter that just this week, Federal Reserve Bank Chairman Jerome Powell, in testifying before Congress, once again reiterated that the central bank has no intention of doing that. In fact, he said just the opposite. That calmed down investors for about a day, but it didn't last. Suddenly, the yield shot up to above 1.50 percent on the benchmark bond, and bond traders panicked. It was as if some magic level of interest rates was unearthed that would suddenly put an end to the entire economic recovery. The bears appear to be betting we are at the doorstep of that level.
It is the main reason why technology shares, especially the large-cap favorites, have been taking it on the chin all week. Higher rates are considered the "Achilles Heel" for that group. It is why the NASDAQ has suffered far greater declines than the S&P 500 Index this week. But these large cap companies are now also in so many equity indexes that investors cannot escape them. If stocks like Apple and Google decline, they will (and are) take the whole market down with them.
This week, we have seen the increasing volatility I have been expecting throughout the stock market. We have also seen another uptick in speculation, both to the upside and to the downside. Bitcoin has had some enormous swings, while gold has dropped to six-month lows. The U.S. dollar was first in a free fall and then soared higher. On top of all this, the Reddit/GameStop crew has returned with a vengeance.
For weeks, I have been advising readers to raise cash gradually while the markets climbed to new highs after new high. If you had followed my advice, you should have a nice pile of cash available at this point in the event that markets take a real tumble. That time could be almost upon us.
As I write this, the markets are battling with an important technical level. A sustained move below 3,830-3,840 on the S&P 500 Index would signal to me that a correction is already unfolding. If so, my potential target would be around 3,550. It hasn't happened yet, but it could. In any event, whether it happens now or sometime in March, that correction is coming. Stay tuned.
@theMarket: Stocks Versus Bitcoin
There was no contest this week. Cryptocurrencies took center stage as the stock market churned, chopped and gave investors a little indigestion. Welcome to the market's brave new world.
It appeared that Bitcoin was the answer to whatever ails you. Higher interest rates, the threat of higher inflation, weaker (or stronger) dollar, no problem just buy Bitcoin. By the end of this week, the crypto coin had chalked up a 15 percent gain and was trading above $52,000. Ethereum, Bitcoin's younger cousin, was also up 10 percent.
None of the financial market's usual suspects — stocks, bonds, or commodities — could come close to those kinds of gains. Detractors warn that the entire cryptocurrency run-up is just a fad and will end badly. Maybe so, but that didn't stop some of the largest institutions on Wall Street to at least consider investments in cryptocurrencies. And while Bitcoin soared, gold has plummeted.
Normally, in times of a weaker dollar and expectations of higher inflation ahead, gold would be soaring. As a result of price declines, traditional commodity analysts have been forced to adjust their bullish precious metals forecasts downward. The most common explanation given for this down draft is that Bitcoin has become the modern-age digital alternative to gold.
After all there is no need to pay storage costs, which you do for gold bullion; nor do investors need to worry about what central banks will do with their gold supplies. As for purchasing power, Bitcoin is accepted at some of the largest credit card companies in the world, as well as PayPal. You can even buy a Tesla with it, if you so desire.
Bitcoin is one reason, but not the only reason, why I wrote last month that although I expected most commodities to do well in 2021, gold was my least favorite among the group. Silver, platinum and copper, for example, are used in industry and are considered part of the re-opening trade. Rare earth metals, such as lithium, which are used in the manufacturing of electric batteries, should also see their prices continue to rise.
Oil has already performed well this year. The shutdown of almost 40 percent of the country's oil production this week, thanks to the deep freeze in Texas and the Mid-West, has resulted in what I suspect could be a short-term, "blow-off" top in oil and gas prices. But, longer-term, I expect energy prices to continue higher.
But what of equities? As we get closer to 4,000 on the S&P 500 Index, (if we actually get to that target) I expect to see more volatility in the markets. Right now, it is all about the stimulus package, which is expected to pass in early March. Will passage be a sell-on-the-news event?
You may have noticed by now that large cap tech continues to advance, but the real action is in small cap stocks. This is also part of my 2021 thesis. What has worked for investors over the last decade (think FANG stocks) may not perform as well this year.
My advice for now is to hold tight, continue to take some profits when you can, and set that cash aside for the future. The next 100 points higher on the S&P 500 are not a sure thing, so be ready for some possible downside as we work our way towards the end of the month.
@theMarket: Financial Froth Infects Markets
One sure sign that stocks are getting overdone, is the actions of overconfident investors that bid up stocks in a euphoric frenzy, only to dump them at the first sign of trouble. These behavior patterns normally usher in a corrective stage in the stock market, but exactly when that will occur is anyone's guess.
Investopia's definition of froth "refers to a market condition where an asset's price begins to increase beyond its intrinsic value." Wall Street's "Reefer Madness" event this week is just such an example. Certain stocks in the Cannabis sector saw their share prices double and then triple in a matter of days. Penny pot stocks with little to no fundamentals skyrocketed higher as well, notching up 50 percent gains or more each day.
I, for one, was quite happy with those results; at least at first. After all, marijuana stocks were on my 2021 list of sectors investors might want to consider this year. My reasoning had more to do with expectations that Congress would finally legalize the substance. If so, it would allow companies to finally access capital from the banking sector, and possibly trigger a wave of mergers and acquisitions. I never counted on a Reddit Raid by traders.
Evidently some investors, emboldened by their success in pushing up (and then down) some stocks like GameStop and AMC, turned their sights on pot stocks. While traders couldn't get enough of these shares on Monday and Tuesday, by Wednesday those same stocks saw declines of 50 percent or more. But those stocks were not the only example of froth. Bitcoin had its own bout with buyers.
Cryptocurrencies were another area, which was on my recommendation list for this year. Bitcoin soared this week after Elon Musk announced that his company, Tesla, the electric vehicle manufacturer, had invested up to $1.5 billion in Bitcoin last month. Bitcoin gained 25 percent this week as a result. Several stocks that were leveraged to cryptocurrencies did far better than that.
Platinum, and platinum stocks (another of my recommendations), hit six-year highs as well this week. Let me go on. Special Purpose Acquisition Companies (SPACs) of all shapes, sizes, and colors are being snapped up faster than they can be created as well. No never mind that the majority of these investment vehicles in search of an asset have left investors holding the bag more times than not if you wait around too long to sell.
It has gotten to the point that traders are now monitoring the feed of Reddit, the internet App, as well as tweets from "Wallstreetbets," which is popular with the Robin Hood retail crowd looking for clues on the next stock or sector that could rise from the ashes.
And yet, if readers were to simply look at the major averages of the stock market, nothing much has happened this week. The S&P 500 Index made minor new highs, as did NADSAQ, but then fell back again. If anything, the indexes have simply consolidated this week.
One would think that a series of successive new highs, combined with a series of frothy escapades, would lead to a wildly bullish investor base. Not so. Instead, recent fund flows suggest investors are rather cautious on stocks. Fund flows have favored bonds, rather than stocks since the beginning of the year.
Bullish investment sentiment, as measured by the AAII Index, also fell in January and has still not recovered. Since the beginning of the year, money market cash has increased by $10 billion and roughly $50 billion has been pulled out of equity funds. One possible reason for the sour sentiment could be the froth I have been referring to.
Media coverage of some of these massive, short-squeezes and the rapid rise and fall of stocks (and even commodities such as silver) may have frightened off the more conservative investor — at least for now.
As readers are aware, I have been advising that you take some profits in investments in which you have out-sized gains. I have been taking my own advice this week. I sold some of those stocks that had run up to what I considered nose-bleed levels. I will continue to do so if the opportunity presents itself. I expect we may see one more surge higher (2-3 percent) before we encounter a more serious pullback, so enjoy the froth while it lasts.
@theMarket: Stocks Regain Momentum
What a difference one week makes! Stocks recouped all their losses this week, and then went on to make new highs. The outcome of President Biden's proposed stimulus bill will determine the market's next move.
Let me set the record straight. Last week, I wrote that I expected stocks to stumble, and hopefully preparing readers for a possible decline of 10-15 percent. That was a mistake. Instead, traders bought last week's 3 percent dip and, at this point, we are now back to square one. Well, not quite.
The U.S. dollar, the 10-Year U.S. Treasury Bond, and the price of gold have all moved substantially since last Friday. The greenback, as represented by the U.S. Dollar Index (DXY), has gained 1.22 percent. That may not sound like much, but in the world of currencies that is a big move. If it continues to gain momentum from here, we could see some of the biggest natural resources gainers in the market hit a brick wall.
As for interest rates, the yield on the 10-Year Treasury Bond is now hovering in the 1.14 percent-1.15 percent range. The rise in rates is a reflection of the current negotiations underway in Washington over the timing and amount of the latest stimulus package. Here's why.
There is a whole breed of bond market investors out there (called Bond Vigilantes), who are quick to buy or sell bonds based on how they interpret the government's monetary or fiscal policy moves will impact inflation. In this case, additional stimulus by the Biden Administration would be considered inflationary, so the Vigilantes are selling bonds. Remember, there is an inverse relationship between the price of bonds (which are going down) and their yield or interest rate. Prices down, rates up.
Commodities, and to some extent, emerging markets, could experience a bout of profit-taking if interest rates and the dollar continue to climb higher. Which brings us to precious metals, specifically gold and silver. This week, gold fell below $1,800 an ounce, since a stronger dollar and higher interest rates are like kryptonite to gold.
Normally, silver would have declined as well with its bigger brother. And it has, but not nearly by the same percentage points. You can thank the Reddit/Robin Hood traders for that. After their initial success with Game Stop, some retail speculators believe they can push the heavily shorted silver price higher by large and concerted purchases of the silver Exchange Traded Fund (SLV).
I doubt they will succeed, since silver is a huge global commodity that would require a heck of a lot of buying power to do more than move the silver price on a short-term basis. I would not recommend readers participate in this endeavor, although I do like silver for other reasons; but wait until the speculation subsides.
We are halfway through earnings season and investors have been pleasantly surprised by the results. Initially, Wall Street was bracing for an average 10 percent decline in the numbers, but at this point, the shortfall overall is less than 1 percent. Those results breed confidence in analysts' projections for this year, which are in the 20-25 percent-plus range right now.
Those expectations are based on the success of the U.S. vaccination program and the reopening of the economy. It is why I am bullish over the medium-term, even though I am still of the mind that somewhere ahead in this first quarter we will experience a pullback. On the upside, I could see the markets possibly approach the 3,950-4,000 level on the S&P 500 Index in a burst of irrational exuberance.
As the market climbs, I continue to advise investors to slowly-but-surely take some profits in those stocks where you have experienced outside gains. This is not market timing. This is common sense talking. You will be happy you did, if only because it will afford you an opportunity to buy the same, or different stocks at a cheaper price.
@theMarket: A Roller Coaster Market
Investors learned a number of lessons this week. First among them was that stocks, on occasion, can go down as suddenly as they can go up. They also began to realize that it may take longer than expected before this pandemic is put to rest.
Over the last two weeks, I have been warning investors to shuck those rose-tinted glasses and take a more realistic view of exactly where we are in this pandemic relief world. That advise is starting to sink in. This week, the Biden administration, Senate Majority Leader Chuck Schumer and even Dr. Anthony Fauci, the nation's top infectious-disease expert, gave investors a more sobering look at the future.
The distribution and delivery of vaccinations, according to President Biden, was going to take longer than he expected. How much longer is still anyone's guess. At the same time, Senator Chuck Schumer admitted that the Democrats $1.9 billion relief package might not see the light of day if he waits around for Republicans to get onboard. And finally, Dr. Fauci said he was concerned about the impact of some new coronavirus mutations on the existing efficacy of the present vaccines. None of the above should have surprised investors, but in a bull market hope springs eternal, so the bulls were buffeted by the news.
For some reason, investors assumed that the relief package was a done deal and would be passed in a blink of the eye with bipartisan support. Schumer's comments that he sees something passed in "4-6 weeks" was definitely not part of the bull's agenda.
Whats more, it now appears that in order to accomplish at least half of what President Biden wants in his package, the Democrats will have to resort to passing relief measures through a special Senate process called budget reconciliation, which would not require any Republican votes for the legislation to pass.
That news, combined with fresh doubts and concerns over the pace of vaccinations and new coronavirus strains, created a selling frenzy on Wednesday that saw the averages lose more than 2 percent by the close of trading. Thursday, markets sprung back to recoup most of those losses, but then fell again Friday. This kind of volatility is usually a sign of a topping pattern, although not always. I believe a 3,250 on the S&P 500 Index bears watching. A meaningful close below that level would usher in another cascade of selling that could result in a 10-15 percent correction.
The good news is that this week's sharp sell-off did reduce some of the frothiness that has been building up among many small-cap stocks. An interesting sideshow to that trend, which has also caught media attention, was the meteoric rise in GameStop and other heavily shorted stocks.
This video game vendor was the subject of what is called a "short squeeze." That's when a number of sophisticated investors (usually hedge funds) borrow and then sell stock of a company (the short) betting the stock will fall in price. Usually, the pros will keep that position, and when they judge the stock has fallen far enough, will buy back their short and bank the difference.
However, there is a new breed of retail investor populating the stock market. This week, they decided to turn the tables on these short sellers. They discovered the power of the little guy through several social media services like Reddit, that small investors could join together and combine purchases of options that could run up the stock price of down and out companies. They targeted GameStop and successfully forced those who shorted the stock to cover at much higher prices. It worked so well that now the latest trend among these traders is to identify additional shorts that can be exploited. The hunt is on and one of today's pick happens to be silver, a much-shorted precious metal.
Last week, I advised investors to begin raising cash in some high-flying stocks. Many of the stocks that saw the worse declines on Wednesday were in that category. Those kinds of washouts are usually a warning sign of further weakness in the overall market.
Hopefully, some readers did take my advice and are happier for it today, so continue to take more profits as we enter February. There is definitely a 10-15 percent decline in the cards somewhere up ahead, in my opinion. Whether that happens at this level, or somewhat higher, is immaterial. When it happens, in a week, two weeks or three, I will be buying that dip with the cash I am slowly raising now.