The US stock market is one step away from a chain of events that I think could mark the start of a lasting bear market.
The most common bullish case I hear is that there is still too much money for too little asset – that is, cash. Yes, there is an enormous amount of money in our system, but that matters less than the fact that the rate at which it is happening is probably peaking. The rate of liquidity entering markets has slowed since the Federal Reserve fixed the rate for monthly bond purchases last summer. This is not a coincidence with the Nasdaq
In the end, that’s what it all comes down to: foam. With handy crypto tokens worth more than Chipotle and Ford’s market cap, it’s never been more obvious that we’re in a huge bubble of risky assets. Crypto tokens are speculative assets and should be viewed as an extension of the stock market for all intents and purposes. The more important question is not what will drive stocks’ earnings from here, it is what could create an opening to escape the valuations that have been the main source of index gains since. that the Fed reversed rates in 2019.
We saw record ETF flows in the first quarter, which added at an astonishing rate over a year. This makes the market very heavy. Some of the recent flows have gone to value-driven companies, but after the huge volume of transactions of the past two quarters focused on momentum stocks, it follows that the average investor break-even price is probably the most. high than it ever was.
And that’s where that exact moment has such potential to tip the boat.
A popular story surrounding last week’s mighty bond rally is that it’s proof that the Fed is in control. I have argued that I think this matter is fragile. If the surge in bonds last week was simply a correction to the uptrend in yields, that means bonds can move again for any reason – growth, inflation, or just because Treasuries are no longer tracking. reliably the upward trend in prices. Given the quality of recent economic data, the odds favor the upward trend in yields. There has been some discussion as to whether the level or rate of change in returns matters more, but it’s something in between. A move from 1.5% to 2%, I think, would be more problematic for the market than the move we owed to 1.5%, because at least from the bottom higher returns were under everybody. At 1.5%, with economists’ average estimates at 1.8% for the end of the year, there is much less room for surprise.
Another common thing I hear is that stocks have adjusted to the higher rate environment and recent index gains reflect investor comfort with returns where they are. I think it’s fairer to say that investors were relieved that the yield fell sideways and then lower.
After last week’s simultaneous bond and stock rally, the 10-day correlation between the Nasdaq and the 10-year future is back close to one. If the price of 10-year bonds drops again from here – just when investors think the Fed has put the market to sleep – we should expect the Nasdaq to buy into it. Growth funds like ARKK and MOON, the best indicator of the larger high growth, high valuation universe, could fall below support levels, enter formal technical downtrends and create another selling leg. at the Nasdaq. These actions showed few signs of strength (apart from those of Tesla
Many have rightly pointed out that tech stocks don’t have to be tied to rates, but until the correlation breaks, why bet on a change in momentum? It doesn’t matter whether it’s rational or not, but so far the hardest hit stocks since yields jumped have been the most expensive, which is exactly what you’d expect. In February, I used a simple sell price analysis to rank what I thought were the worst performers of a rate spike, based on what happened during the 4Q19 “earthquake” . It was almost perfectly predictive. Newton’s first law adapted to markets: relationships in motion remain in motion until proven otherwise.
I think economic growth will limit how quickly the momentum I’m describing could pull the market down, but if the correction we’ve seen in Tesla and its high-growth peers turns into a trending bear market could be very ugly fixes. Last time around, it was easy for investors to turn to the cheaper economy-related stocks, but, as we see in the recently stagnant Russell 2000, such a spin may not be as powerful this one. time.
That said, cyclical stocks would likely remain the best bet for investors limited by US stocks. The economic progress will help offset the squeeze in valuations with the growth in earnings of these companies. In other words, the bearish momentum I warn about in all of this could end up being specific to the Nasdaq. It is possible that the Russell 2000 and maybe even the S&P 500 will deviate significantly from the Nasdaq for some time.
I will know I am wrong if the yields have a significant move higher from here and the Nasdaq does not fall. It’s also worth noting that there’s a difference between the rush liquidity argument I’m making and the rate panic as a driving force. If the weakness is more related to a drying up of liquidity, bonds could strengthen as the market slows and reverses. I think we’ll know if liquidity is on the line if bitcoin pulls back alongside the market. Bitcoin is the purest speculative trade focused on liquidity, and we should expect stock market valuations to move in sync with Bitcoin. If it’s the rates and fears of inflation that are driving the sell-off of stocks, bitcoin may still have a chance to work in this scenario. Personally, I don’t think it will, but I will wait for more proof. It would be a great chance for Bitcoin to prove that it has macroeconomic ties beyond speculation. More on that later.
Bottom Line: The market looks strong at historic highs, but there are too many risk points to continue to soar higher. Many stocks are above their moving averages, but the number at new 52-week highs on the Nasdaq has been trending down since November. The final stop in the rally was actually a continued bid from the multi-year winners of the growth cohort to high-quality ‘defensive’ tech, then utilities, commodities, healthcare and low-volatility ETFs. . One way to think about it is that the market is desensitizing to interest rate risk. It seems to me more that investors are playing musical chairs after being shocked by the forced sale of rates in February. If this dynamic reappears, it can cause panic.
I wrote in February that stock bulls face the ultimate interest rate boss. If the rebound in yields from here occurs and the dominoes don’t fall as I expected, then I just have to say ‘buy’.