Over the long U.S. holiday weekend the S&P 500 sneakily made its way above 2975 and hit 3019 at one point on Tuesday. We are now back at the level of July and October of last year; it is also the key 200-day moving average for the market.
The bulls and bears have been in this constant tug of war trying to break 2975 to the upside or 2750 to the downside. The bulls clearly have the baton here as news on Monday of a company starting human vaccine trials, though nothing about safety or efficacy was discussed. The algorithms read the word "trials," "moving forward" and "vaccine" and decided to buy up the S&P 500 futures without questioning the rationale that no data were given or knowledge of how soon a vaccine actually can be made. The broader market has been in a six-week, 150-point range-bound mode, consolidating slowly as it looks to make its next move. Which one will it be?
A chart plotted recently compared the average performance of Retail Money vs. Smart Money. The former is defined as day traders and high net worth individuals, not necessarily finance professionals, versus the latter consisting of sophisticated hedge fund managers and institutions. The Retail Money has been outperforming Smart Money this year as the latter is down 9% year to date.
Historically speaking, every time the indicator got this stretched the market unwound sharply, like in March 2020. Retail investors are mostly long the technology stocks, namely Apple (AAPL) , Amazon (AMZN) , Alphabet (GOOGL) , Facebook (FB) , Microsoft (MSFT) and the like. These names now make up almost 22% of the market cap of the index and these are also the names usually in the Hedge Fund VIP basket.
Depending on where or when they bought the market dip, they have done well purely on the basis of the last 12 years of trading history and the Federal Reserve always coming to the rescue of the markets. It does not require financial or sophisticated expertise as the Fed has rewarded and reinforced very well that all markets dips are to be bought as the Fed has traders' backs. This self-fulfilling prophecy has allowed risk to be elevated to such a heightened level that even experienced managers are now claiming market can never go down and blindly are following it higher as opposed to questioning all the moving parts, which is what they were trained to do. It is all luck and blatant ignorance now.
Only while it lasts, that is.
Investing is all about risk versus reward. If one did not buy the dip back in March, chasing it now is dubious. The Fed is clearly underwriting certain markets, especially the high-yield and junk bond markets. They are exposed to these toxic companies via the Blackrock BLK ETFs iShares iBoxx Investment Grade Corporate Bond ETF (LQD) and iShares iBoxx High Yield Corporate Bond ETF (HYG) . Everyone seems to rejoice in that fact, but not question the logistics and actual administrative difficulties of those purchases.
Hertz (HTZ) bonds are one of the names in those indices that have just defaulted. Does the Fed know what it has gotten itself into? Is it set up or even know how to deal with managing a situation where it might end up owning a percentage of a company post-bankruptcy?
How many more bonds will default and the Fed be long the post-bankruptcy equity? The Fed is going to turn into more of a distressed debt hedge fund than a central bank as it will not be able to liquidate these bust holdings.
The amount of bankruptcies and defaults will only rise in the coming months. The Fed's so-called endless liquidity is just supporting the market, buying it time, but it cannot force companies to grow, spend, expand or hire, nor can it entice consumers to spend. As economies reopen slowly demand is going to return, but the extent is nowhere close to the levels we saw prior to the Covid-19 lockdown.
Now that we have rejoiced in the reopening rally, it is time to look at how quickly demand recovers and economies regain their footing. Investors have written off second-quarter earnings and are focusing instead on 2021 multiples and recovery. That is all well and good, but if the sell side is not adjusting numbers down for this year how are investors to get any reassurance as to what the true multiple is?
Another argument used by bulls is that the dividend yield of the S&P 500 versus bond yields has not looked this attractive since the 1940s. That makes sense if you trust the dividend figures of these companies. The implied dividend swap market is suggesting otherwise. Perhaps the dividend yield would look less attractive if adjusted accordingly. With the rate of defaults and bankruptcies rising, even now some U.S. financial institutions are seeing more than 15% of their loan portfolios with deferred payments; consequently, the risks are not well-balanced. For the market to see a true recovery, we need leadership from financials and industrials, among others, not just the technology sector.
Story Is Far From Over
Only time will tell who will be proved correct. Of course, luck and momentum have been on the day traders' side, but as the old saying goes, if you do not understand why you are making money then you should not be trading.
The Fed has done an incredible job of supporting asset prices as it fears any collapse of equity prices will lead to a domino-effect collapse in broader parts of the income stream. It represents an end to the Fed's financial sham of the past two decades. However, the Fed is backed into a corner now and it is printing more debt to service the old debt, building layers upon layers, leading to lower productivity. It may have stabilized asset markets, but expecting a V-shaped recovery is a tall order.
Even if one were cynically bullish here, it might be prudent to be in cash and wait out the next one to two months and see what the real economy's second derivative impact is post the lockdown. At these levels, it may be worthwhile being flat and patient than long and wrong, especially when all broader macro indicators are still showing stress in the system.
How much longer can the chants of "the Fed has our back" go on without substantial fundamentals to back it?