Markets love known quantities. Former Federal Reserve Chair and current Secretary of the Treasury Nominee Janet Yellen is certainly one of them. The S&P 500 (SPX) rose at a 12.6% compounded rate during her term at the Fed, giving confidence to investors that she will do little to disrupt the smooth functioning of markets and the economy. Stock markets reward performance. Yellen delivered that.
It was little surprise that stocks rose after her announcement yesterday and continued to rise today as we further digested her selection. The news that the General Services Administration was finally recognizing Joe Biden as President-elect certainly helped as well. Markets also rose on the news that Pennsylvania certified its electoral results. We appear to be putting the electoral chaos behind us, which should quell most of the residual worries that accompany that uncertainty.
The list of stocks, indices, and other investable items that are at or near all-time or long-term highs is enormous. As I write this, the Dow Jones Index (INDU) is flirting with the 30,000 level, while Bitcoin approaches $20,000. Both may well have crossed those thresholds by the time you read this. Why not? They both seem to go up every day.
That last sentence that worries me. It is difficult, if not foolhardy, to get in the way of the multiple freight trains that are racing through the markets. Right now, the market seems to have the best of both worlds, pricing in a robust post-vaccine recovery and overlooking a potentially frightening present and near-future. We are effectively ignoring the expiration of rent and student loan moratoria at the end of next month, among other things. (How much of the rally has been fueled by small investors speculating with their deferred student loan payments?) To a degree that focus on the longer term is ok – markets are supposed to price in events 6-12 months away. But how much of it has been priced in already? And what happens when the Fed decides that it’s ok for long-term rates to rise?
The one-way markets are showing real signs of froth, though. I am concerned that the relentless rotation is turning into a speculative bubble. Among the signs of frothiness are:
- Bitcoin – it’s parabolic again, up about 70% in a month for no apparent reason.
- Junk bonds – the weakest credits are near record low yields
- The overall options market put/call ratio is trading around record low levels not seen since 1999 and 2006. Those dates should ring a bell with investors
- EV stocks – only Tesla (TSLA) is going into the S&P 500, but they’re all on fire
- Pot stocks – had a flare up after the election, fell off, but are ticking up again
- Big cap tech – though to be fair, that love affair is fading. In the short term that could further fuel rotation. The market cap of the Russell 2000 is a bit more than AAPL. If some money flows from the big tech stocks into RTY it further fuels its outperformance. But if money seriously flows out of the biggest names in NDX, SPX has nowhere to hide
This is why I question whether this could be why VIX and VIX futures remain so firm. VIX futures have been continually pricing in roughly a 1.5% daily move through mid-summer. That outlook does not jibe with the rosy outlook displayed by the stock markets as a whole. Is this a reflection of large investors hedging their stock and junk bond portfolios with VIX futures, or is there something more dysfunctional at work? That remains to be seen in the coming weeks.
In the meantime, it is difficult to draw conclusions during a holiday shortened week. With US markets closed on Thursday for Thanksgiving and celebrating Black Friday with a half-day session, volumes are likely to be lighter than normal. It is hard to see a major turning point occurring during a light volume week. Enjoy your turkey, enjoy the rally, but please remember that risky trades that work really well have a nasty way of turning around unexpectedly. Be wary of overindulging either in holiday goodies or frothy markets.
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