By David Nelson, CFA CMT
With 2021 setting up to be another record year for equity investors it’s not surprising to see headlines like this weekend’s Wall Street Journal article Americans Can’t Get Enough of Stocks.
Year to date every sector is in the green with Energy on top and Consumer Staples bringing up the rear. Add the fact that 93% of stocks are trading above their 200-day moving average it’s pretty clear we’re in a raging bull market.
The meteoric rise off last year’s bottom on the heels of a bear market that lasted just 23 trading days has pushed bears into a corner with retail investors thumbing their noses at professionals. Even the legendary Warren Buffett was called out this weekend at the Berkshire Hathaway Annual meeting for not taking advantage of the price opportunities from last year’s panic. Warren’s statement says it all; I don’t consider it a great moment in Berkshire history…
While it took just 126 trading days to reach another record high off the pandemic lows it’s fair to point out it took 7,692 days following the crash of 1929 to achieve the same milestone. Maybe that can’t happen again with a Federal Reserve ready to provide any level of liquidity needed but it certainly points to the elephant in the room. Valuations have a direct correlation to the risk-free rate which is effectively zero.
The logical conclusion is the next correction or bear market will likely be triggered by a Fed forced to take action on some other battlefront like inflation or lack of confidence in U.S. debt. With GDP exploding and Washington set to push deficits and balance sheets up by $Trillions the inflation fear takes on new meaning.
Low rates have forced investors to increase the size of their equity holdings as percentage of financial assets to the highest in 60 years, above even the dot com boom. Investors who are maxed out in their accounts but looking for more action add margin or turn to options to increase leverage.
5 Years, 5 Months or just 5 Days
One by one investors will get forced out of their comfort zone and feel the urge to add more to risk assets. Ultimately, that will prove their undoing. This bull market could last 5 years, 5 months or just 5 days.
For the moment rates have stabilized and equities are still the better asset class, but we’ve seen the damage of high rates and just how fast institutions can dump stocks when they decide to de-risk. In 2018 the 10-year level was close to 3%. You couldn’t get out of stocks fast enough. It wasn’t until Fed chair Powell blinked and moved back to accommodation before the blood letting stopped. If an opportunity arises where institutions like insurance companies and pension plans can match future liabilities with a more stable asset class, they will be quick to rewrite the playbook.
COVID – There’s still a lot we don’t know
There’s still a lot we don’t know about Covid. Over the weekend, India with a population over 1.3 Billion logged 401,993 new cases of Covid and seems to be dealing with a more lethal variant B.1.1.7 first found in Britain. So far, here in the U.S. current vaccines appear to be holding up well. However, the administration has announced they are suspending almost all travel from India to the U.S. starting May 4th. The travel ban is indefinite.
The point I’m trying to drive home is the next correction or bear market will likely come unexpectedly and with little warning. More importantly, it may happen during a time when a rising number of Americans are in the distribution phase of their financial life cycle with their earning years well behind them.
If you’re living out of the zone but your decision is to plow ahead pedal to the metal than at least use interest rates as a guide. Each stair step higher in rates challenges the bull thesis. If history is any guide, we still have about another 100 basis points of runway left for 10-year rates to move higher before fixed income starts to get competitive.
Earning’s Season
Analysts have been struggling to keep up with the economic acceleration with most consensus estimates falling well under reported numbers.
Amazon
The challenge: – we’re in the middle of a very important earning’s season that hast to both justify the record highs but at the same time set the stage for continued growth after the wave of stimulus money runs its course. Anything less than a monster beat has been met with selling. Even Amazon (AMZN) which traded up 100 points late Thursday after reporting $15.79 vs a $9.55 estimate ended Friday in the red.
*At the time of this post some funds managed by David were long AMZN
