Many complex factors move the stock market, but at its heart it is simple supply and demand. The supply of stocks and the level of non-invested cash ultimately will determine how stocks act.
The thing that has driven the market more than anything in 2020 is the flood of liquidity that was created by the Federal Reserve to deal with the Covid-19 crisis. That high level of liquidity has persisted for months and there continues to be a surge of inflows that is pushing the indices to all-time highs.
Market participants hope Janet Yellen as Treasury Secretary will help keep this going by encouraging Congress to come up with fiscal stimulus deals. Liquidity has not been a big issue, but there is likely to be some increased demand as many companies look to take advantage of the current high prices.
Here on Tuesday morning we learn that Tesla (TSLA) has filed to sell $5 billion in common stock as there is likely to be a surge in demand for its shares due to the company's addition to the S&P 500 on Dec. 21. There have been a slew of secondary offerings and there are several big initial public offerings (IPOs) on the docket. DoorDash will soak up around $3 billion and Airbnb will have a valuation of around $30 billion.
This additional supply is going to have an impact on the very strong rotational action that we have seen lately. As I've been writing recently the primary rotation that has been taking place is out of some of the standard growth leadership and into stock picking. Sectors such as special purpose acquisition companies (SPACs), electric vehicles, solar energy and biotechnology have benefited as a flood of hot money has chased strong momentum. The rotation is mainly occurring under the surface of the indices and has rewarded those who have reacted quickly and aggressively.
The big question now is whether money starts to rotate out of the hot sectors and into these secondary offerings and IPOs. Traders typically like to stick with the strongest momentum, but the additional supply is going to attract some cash that has been helping to support the strong momentum.
The key is to stay focused on price action. We will see very quickly if the additional supply is triggering rotation out of the recent momentum favorites. I suspect the hot money will provide some good support fairly fast in stocks that have made big moves, but there will be some profit-taking that makes some trades nervous.
Supply, demand and rotation are going to determine the best trading and we better be ready to react as this develops.