If the market’s job is to confuse and confound, it’s on fire at the moment.
Overnight, US stocks jumped again, with the major indices all rising between 1%–1.5%. The small-cap Russell 2000, so far a laggard in this month-long rally, surged nearly 4%.
Meanwhile, the oil priced collapsed again, down nearly 25%.
US 10-year bond yields are not confirming this rally either. While they increased around six basis points overnight, they are down over the past month.
Falling bond yields (meaning rising bond prices) are an indicator of weak economic growth and/or deflation.
Inflation is not a problem
Put another way, despite all the government spending and the Fed’s insane asset buying, the bond market is telling you that inflation is not a problem.
Which makes sense. The economy (in the US and around the world) is shutdown. Of course that’s deflationary.
Not to the stock market though.
It has a different view.
It’s heroically looking through the lockdown phase and seeing better times ahead.
Maybe it’s right. Time will tell on that front.
But I’m sceptical.
To be clear, I’m not overly bearish. I think the panic lows you saw on 23 March will hold. I’m just sceptical about the pace of the recovery the stock market seems to be communicating here.
Part of the problem is that the market has become so distorted with Fed buying and anticipation of Fed buying, that you really have to look and think hard about what all this means.
For example, in years (decades) gone by, the onset of a crisis would see capital fleeing into the safe haven of US government bonds. That was back when you could still earn a decent yield while you waited for the storm to die down.
A new form of a ‘risk-free’ asset
The bond market still attracts safe haven flows. But it’s no longer the only game in town. Capital is now seeking out a new form of a ‘risk-free’ asset.
It’s called ‘tech’.
Take a look at Amazon.com, Inc [NASDAQ:AMZN]. This crisis has been good to it. Its share price recently soared to new all-time highs.
And here’s a broader look at tech via the NASDAQ. As you can see in this chart, while the initial sell-off was indeed dramatic, prices didn’t even get close to breaking through the 2018 low.
Now the index has recovered so sharply, it isn’t far off from where it started the year. In fact, it’s down around 2.7% for 2020.
What’s going on here?
In short, global capital is herding into large tech stocks for ‘safety’. According to an article in Barron’s magazine, the S&P 500 is now more concentrated with tech stock weighting than any time since…2000. That was the height of the tech bubble.
‘Markets may appear to be staging a comeback from their March lows, but a look under the hood shows the rebound is far from being felt by all companies equally.
‘One fifth of the S&P 500’s market cap is accounted for by five big tech companies, marking the highest level of concentration for the index since the 2000 tech bubble, when equity market concentration stood at 18%, according to a note published by Goldman Sachs. Just before the coronavirus pandemic, the five companies — Microsoft (ticker: MSFT), Apple(AAPL), Amazon (AMZN), Alphabet (GOOGL), and Facebook (FB) — matched 2000 levels.
‘With the tight concentration of these five names, the S&P 500 is just 17% below its February record high. However, the median stock in the index trades 28% below its high, showing the distortion of having the five mega-cap tech stocks performing so well.’
This lack of stock market ‘breadth’ (meaning the lack of a broad number of companies driving the move higher) casts a big question mark over this rally.
But such is the impact of herd-like behaviour, not that anyone really notices or cares. Safety feels safe, even if it’s not.
That’s the problem with humans and the stock market. We have evolved to survive in nature, not in the stock market. In nature, the herding instinct promotes survival. In the stock market, it will promote your slaughter.
I think you’re seeing a similar situation to what happened back in 2001. I mentioned this to subscribers of my Crisis & Opportunity newsletter last week.
Back then, we had an external shock to the global economy in the form of passenger planes flying into the World Trade Centre.
Stock markets plunged on the news. But then the Fed and central banks came to the rescue, pumping emergency liquidity into the market and cutting rates. Sure enough, stocks rebounded.
The chart below shows the ASX 200 at the time. It was already under pressure when the planes hit. But the plunge was short-lived. After bottoming in mid-September, the index went on to rally nearly 20% over the next six months.
In fact, stocks went on to hit marginal new all-time highs.
But that was as good as it got. The market then rolled over. Central banks interfered with the cycle, but they couldn’t stop it playing out.
It’s a similar situation now. There is a high likelihood that the COVID pandemic was the catalyst for the end of the cycle. After all, the global expansion was already one of the longest on record.
Sure, the Fed will do everything it can to keep the cycle going. Like humans in general, it has learnt nothing from history, even very recent history.
So my best advice here is to stand aside and observe the herd-like behaviour taking place. But this is not the African savanna. There is no such thing as safety in numbers.
PS: In a brand new report, market expert Vern Gowdie warns of the dangers waiting in a post-COVID-19 world. Plus, he outlines the steps you must take now to protect your wealth. Learn more.