Back to the Grind -- in Work and Stocks?

Labor Day marks the unofficial end of the summer. Time to shake off the cobwebs and get back to the grind. But this fall -- with the Covid outbreak continuing, election looming and major stock splits behind us -- we have several lingering questions. The first of which is, will the stock market grind continue? Stocks have rallied non-stop since the middle of June. It seemed like virtually every day, the stock market rose, albeit led by relatively few stocks. The S&P 500 is up about 15% since the middle of June, but the S&P market-weight index is only up abut 8% in that same time span. The divergence between the high-flying Nasdaq 100 and the Russell 2000 is even more striking. On Tuesday at approximately 10:30 a.m., that pattern seemed destined to continue. I had thought that the stock splits that occurred on Aug. 31 could be a sell the news type of event. That looked like a disastrous idea as the stocks that split led the market higher that day, and surged yet again the moment stocks started trading after the close. That continued into early trading on the next morning, when things started to reverse course for some stocks, but not the broader market. The Nasdaq 100 closed at an all-time high on Wednesday, but has slumped since then, and this first day of post-summer trading looks to be weak as well. So, is it back to the grind? As we logged into our computers on Tuesday morning and trading gets into full swing, will we go back to the relentless grind we saw, or is that over? I suspect the grind is over and we are due for some volatility. Let's look at that possibility. First, Wall Street seems to believe the Robinhood traders only trade to the long side and will support this market -- I think that is incorrect. Second, stock prices had become just a number. We had that moment in time when valuation didn't matter; it was all about the last tick on the price and where the momentum was taking us next. Valuations and market cap seem to matter again. Third, we must ask: Can most stocks trade higher while the indexes drop? That is a question that no one was asking last weekend, but seems a valid question now. Are we finally going to see the rotation? Financials, when looking at the Select Sector fund , are still well off their June highs. Could we see support for these types of industries and companies that haven't fully participated in the rally, while seeing some high fliers lag and drag indexes down? It seems possible, since it would just reverse much of went on for the past few months. What Are Our 'Options'? But we have another question: Could options buyers come back on Tuesday, now that stocks are cheap, and restart the whole process? That is possible, but I don't think it is likely for several reasons. First Volatility is higher, driving the cost of options up. Options that expire out of the money are worthless. I've been inundated with all sorts of options trading strategies that guaranty to make 100% or 200% or more returns. Yet, little has been discussed about losing 100% of your premium. These market players might like calls or learn that they can push stocks lower sometimes, as easily as they pushed them higher. That Tesla did not get included in the S&P 500 on Friday, after the close, when changes were announced, means there will be less selling pressure on the existing stocks in the S&P 500 and managers don't have to make room to absorb the behemoth that is Tesla. Having said that, both the rotation trade and the re-opening trades stand to benefit from a reversion, and I expect that process has now started and has some room to run. Rates Aren't a Great Hedge On Thursday, as stocks sold off, Treasuries barely provided any offset. On Friday, Treasury yields rose substantially, ticking back up to 72 basis points (the high end of its recent range). While Treasuries are better on Tuesday morning, they are only marginally so. Supply is high on the Treasury side and corporate debt side, so that is hampering the ability of Treasuries to rally and act as a hedge. So is Fed Chief Jerome Powell's commitment to create inflation and unwillingness to consider negative yields. One of the biggest risks to the stock market is a significant rise in yields, though that seemed unlikely to occur. But since the Fed's Jackson Hole event, where we viewed the Fed as catching the tiger by the tail, Treasuries have traded poorly (and we had stories about China reducing their exposure). We started to see record low real yields become slightly less negative at the end of last week, but there is a lot of room for that trade to unwind. Credit Spreads: A Brief Wobble I don't want to be alarmist, since the U.S. Investment Grade Credit Default Swap index only went to 67 bps on Friday from 62 bps, but credit has been sluggish relative to equities -- or, to be more accurate, has simply been impacted by the lack of breadth in the equity market. So, it is difficult for credit to go a lot tighter with bank stocks languishing. The iShares TR/iBoxx U.S.D. Investment Grade fund , the most famous of the credit exchange-traded funds that the Federal Reserve has been buying, traded briefly at a discount to net asset value in the middle of August and was there again last week. The discount to net asset value was minimal (likely just a rounding error), but this ETF has traded at a significant premium to net asset value, since the Fed announced that it could buy ETFs (it traded well from the day of the announcement, long before any shares were purchased). I keep a close eye on net asset value on the ETFs, because it is often a leading signal for market direction. I cannot say that this indicator (across a series of ETFs) is flashing red, or even orange, but let's call it a yellow flag. Something else to keep an eye on. We will not see a repeat of the disastrous trading we had in March when ETFs were all over the place, but there is no reason that an ETF that increased shares outstanding by a whopping 75% since the Fed announced their intention to buy, to experience some outflows and put additional selling pressure into the market (I talk about LQD in particular, but a similar pattern is apparent in almost every fixed income ETF). My Take: Be Bearish on Rates I'm bearish on rates -- look for the 10-year Treasury yield to drift to 1%. Look for curves to steepen. I'm also slightly bearish on equities, but bullish on a rotation/mean reversion trade. Credit, should be fine, but be a little nimble and save some dry powder for some potential selling pressure.

Back to the Grind -- in Work and Stocks?

My bet is the grinding is over, and the volatility is here.

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