Today’s report will be a little different than usual. There once again isn’t much new to say about the short-term setup in the market, so while I will discuss that a little, the main emphasis will be on the bigger picture and some of my general thoughts about where we may go from here. As always, my views are not set in stone and will be subject to change with the market, but I want to at least provide somewhat of a roadmap for how I’m currently positioning portfolios. It is clear the markets are at new highs: check ✅. It is clear that inflation is on the rise in many different places: check ✅. It is clear that third-quarter earnings and revenues—as well as future guidance—are coming in higher than was initially expected in many cases: check ✅. But IT ISN'T THIS EASY. THAT WAS THEN AND THIS IS NOW!!!!!
First, though, the general stock market in the near term continues to churn around all-time highs. In my view, this is a good thing and is likely setting us up for another push higher. Seasonally this is true, but this market can be tricky, and possibly just what we are hopefully expecting could end up being "different this time." The only real question I have is whether we get one more small wave down first or if a couple of weeks of choppy trading has been enough to recharge stocks. Please reference the chart in last week’s letter for a very clear picture of this.
I honestly don’t have a lot of conviction either way right now because I don’t think the market is sending us strong signals. As I said in the first paragraph above, we are at high levels of good data. As I write this around midday Saturday, the S&P 500 is up around 0.5%, but there are currently more declining stocks than advancing (by a small margin). Over the past several sessions, the percentage of advancing stocks on the NYSE has been as follows: 52%, 50%, 36%, 61%, 55%, 49%,46%. Not bad, but not strengthening either and not really indicative of major selling or strong buying. Unless the latter arrives, we’ll be at risk of some more down days that can push the indices marginally lower. However, I believe in the immediate term the S&P 500 is likely to stay above 4550-4600 and Small-Cap Value and Large-Cap Growth are likely to stay in their respective higher ranges, with hopefully limited downside. In general, I continue to proceed as if we will go higher in the coming weeks even if it’s not a straight path higher.
- From a technical perspective, there isn’t much that’s jumping out as a major concern at the moment. There are ALWAYS some signs of a pending top, which tend to get zeroed in on by those perma-bears with an agenda to promote fear, but on balance, there is very little that makes me think a major top is imminent (take another look at the chart above). With most U.S. equity measures near all-time highs, including the Small-Caps (which just broke out from a multi-month range), the market seems to be signaling that it expects the near-to-intermediate-term future to be OK. I often get asked what it would take to turn me more bearish for the long term — that’s tough to answer, since my balance of evidence approach is ultimately a subjective call based on a vast number of different indicators and data points. At the very least, it would likely require the major indices to start breaking down through key support points. In the S&P 500, the recent low around 4300 appears to be the "mattress top." I say this to mean that a hard number means little. For any of a number of reasons, market pullbacks are a process, not an event, so I say "around" this price, sort of like when you lay down on a mattress you initially sink in and then settle at a point. I don’t think this mattress top should be violated if the market remains on firm footing. Below this level, and I think it would make sense to be more cautious; but as long as we remain above there, I think we have to assume any dips are within the realm of normal volatility.
- From an economic/fundamental perspective, barring a true black swan (like another wave of mass COVID shutdowns), we probably shouldn’t be in major trouble until after the Fed starts raising rates. Usually, it takes at least a couple of hikes before we get a significant stumble in stocks since there is typically somewhat of a delay between when monetary conditions tighten and when the impact is felt in the economy. However, with unprecedented levels of existing liquidity and fiscal stimulus, who knows if history even matters anymore! If anything, I think seeing another “blow-off " type leg to the upside to suck in every last dollar is a better bet than seeing massive downside straight from here.
- The Fed raising rates isn’t what really concerns me in the bigger picture, though. I think the much greater threat is what happens if they don’t raise rates soon enough or if their pace of tightening once begun isn’t enough to combat what are already high levels of inflation. Inflation continues to be the major buzzword across the market, but unlike many supposed threats to the economy and stocks, runaway inflation worries me more than perhaps anything else. The reason for that is I don’t know if the “powers that be” would be willing to use the tools required to combat extremely high inflation since those actions would be very politically unpopular. Over the last 30 or so years, the solution to every economic problem has been to juice the system by providing stimulus and liquidity to inflate us out of trouble. “If all you have is a hammer, everything looks like a nail," particularly if that hammer seems to always do the job. But what happens if throwing more liquidity and helicopter money at a problem just makes it worse? If we get into a situation where prices and costs are prohibitively high, using stimulative measures to spur more demand would pour gasoline onto the raging fire. But taking the opposite steps of trying to curb demand and reduce liquidity 1) risks “stagflation” if it just slows down the economy without significantly lowering prices, and 2) requires buy-in from politicians whose only goal is to be re-elected. With another trillion dollars in fiscal stimulus hitting the economy, it does not appear cooling things off is on the table for now.
- This is what really worries me about the bigger picture. At the moment, more focus seems to be on taking steps that could end up making inflationary conditions worse rather than better. For instance, I’m all for the gradual transition to renewable sources of energy, but we can’t expect to flip a switch and have it happen immediately when so much of the current energy output (and inputs) requires fossil fuels. The global powers are determined to set us on the path toward the transition to renewable energy sources, but I expect that path to be very rocky with major bumps along the way. Coal, in particular, has been in the political crosshairs lately, but according to Bloomberg, “Coal stockpiles at U.S. power plants plunged to the lowest in at least 24 years as electricity generators burn the fuel faster than miners can dig it out of the ground.” It’s a similar story with fossil fuels, in general, as years of underinvestment will make it harder to just ramp up production when needed. It doesn’t take a major in economics or a CFA charter to see the potential for much higher Energy prices or even Energy shortages when active steps are being taken to both spike demand and hamper supply. Moreover, one point that is not usually mentioned when discussing the switch to renewables is that many of these alternative energy sources currently require fossil fuels to manufacture and/or run. So, it’s not likely to be a quick transition no matter how many headlines are written about it.
- The upshot is that things do have the potential to get very bad if inflation turns out to not be transitory and cannot be appropriately dealt with. I have it as the number one risk for what could ultimately end this long bull market and create another crisis-type environment that may take years to recover from. I don’t think it’s an immediate threat — the combined powers of historically low interest rates and loose monetary and fiscal policies are likely too great for that — but after several successful attempts to throw more debt-fueled money at economic problems, I do worry what will happen if that playbook no longer works. The risks aren’t just an Energy crisis, but a food and labor crisis as well, and that’s when civil unrest really begins.
For those of you who have read my reports for a while, hopefully you know I am not one to sensationalize or promote fear for the sake of it. So, when I write about something like this, it’s because I think it’s something we need to at least keep in the back of our minds as we go forward. I don’t think the next bear market is coming soon, but when it does I think it has the possibility of being painful. The other part of this is that we are now 12-13 years removed from the Global Financial Crisis and 20 months from the COVID crash lows. There aren’t many areas of the market that appear to be at an extreme value standpoint while many are at or near historical peaks in valuation; so, we need to put more emphasis on making sure we’re in the right groups and limiting risk in groups that could stage a big fall if conditions change. Over the short term, what looks attractive changes frequently and I try not to be myopic and highlight those opportunities in these reports. However, when we’re talking about bigger picture investments, I increasingly want exposure to “real stuff" and stocks that are in the way of where the world's consumption appears to be going. By “real stuff,” I mean the things that people and companies need even if prices continue to rise: Energy, Food, Housing, Natural Resources, etc. Stuff like this.
Again, this is speaking more toward the bigger picture over the next few years. In the interim, I do think stocks as an asset class go higher and maybe even much higher. The massive amounts of liquidity and stimulus can kick the can pretty far down the road, but I do think we will eventually see a day of reckoning, and I know I want to be on the right side of that when it comes. This is why I think it’ll be crucial for us to honor and respect major support zones and get extra cautious should they break. The crowd can also get pretty crazy near the end of bull markets, so we also need to watch sentiment carefully and try to avoid areas that look particularly “bubbly” and overly concentrated. Anyone can make money in the market; keeping it is another matter. The renaming of Staples Center in Los Angeles begins to smell like a "bubbly" sort of situation.
Bottom Line: I don’t have much to say here that I didn’t say above or over the last couple of weeks. In the near term, I don’t have a strong conviction on where the markets should go immediately, but I still believe any dips will be shallow, and stocks probably rise in the weeks ahead. That’s what "should happen," so it will be a sign I need to re-evaluate if it does not. But the trend remains up, monetary and fiscal policies remain accommodative, and it’s been a successful earnings season so far with most S&P 500 companies having now reported and 81% beating EPS estimates. If we are going to get a surprise move from here, it feels like it’s likely to come on the upside, so I don’t think we should get too cute with trying to time it perfectly. Those long-term resistance levels in the S&P 500 and NASDAQ remain in place and are the biggest technical hurdles to overcome, but there is no rule to say that they can’t be overcome.
I wish you all a very Happy Thanksgiving with friends, family, and NO MASKS. Please, as always, feel free to call should any questions arise about your personal portfolios or if your investment goals have changed.
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