“Bull Market,” Says Who?

Join Chris Perras for the 3/12/2021 edition of Stock Talk!

Chris Perras: Good morning. I’m Chris Perras, Chief Investment Officer at Oak Harvest Financial Group here in Houston, Texas. Welcome to our March 12th, weekly Stock Talk Podcast: Keeping You Connected to Your Money. Well, did you blank? Did you listen to and focus on the daily pontifications by bond managers, economists, and TV analysts about the 4% drop in the S&P 500 and the 10% drop in the NASDAQ? It took it back to flat year today.

Did you sell because of all the noise of the coming headwinds of inflation? Man, I hope not. Did you keep yourself from buying additional shares in companies that you liked because they were red for a few weeks, and the professionals on TV that you’ve never met said, stay away from technology or stay away from high growth stocks in favor of value stocks?

Well, this week’s podcast title is an ode to one of my favorite songs by the British rock band, ‘The Who’. This week’s title is It’s a Bull Market for Stocks. Says who? Says, David Tepper, don’t get fooled again. I’ve been saying now for about six months, you can’t be short stocks in 2021 after the first week in March. We shook out the short term and nervous investors focused too much on the gyrations of the bond market, the TV commentator, and the newsletters dire forecast of 10% to 20% corrections and warnings of bubbles in every asset class.

The data of what has happened in the last 12 years during rising long-term interest rates in the treasury market not caused by the federal reserve, raising short-term rates and tightening monetary policy is very much a different story than the on TV. All others were almost hysterically decrying the return of inflation and how bad it would be for the markets. We were out trying to explain to listeners that not all rising long-term interest rates environments are bad for equities.

In fact, equities are one of the best places to be in a slowly rising long-term interest rate environment. My hedge fund hero, David Tepper of Appaloosa Management came on TV this past Monday in one of his rare appearances. He’s essentially retired. He only comes on TV when he has something new to say versus others who come on and wax eloquently on a daily or weekly basis, depending on whether their screen is green or red.

Guess what David Tepper said? He said, “Bond interest rate worries are overstated and rates have likely peaked for now, buy stocks, in particular, buy large-cap tech stocks and secular growth stocks.” The facts are this cycle, for the past 12 years, the overall S&P 500 has benefited from a rising interest rate environment in longer-term treasury yields. Why? Because that rise foreshadows a needed uptick in inflation for 9 to 12 months, and its subsequent increase in real growth for another 9 to 12 months.

During the second Obama presidential term, long-term interest rates– listeners, listen to this. Long-term interest rates rose by 150 basis points. They rose by 1.5 percentage points from the election through the first quarter of 2014. Guess what the S&P 500 did? It rose 37.66%.

Fast forward to President Trump’s election in November of 2016. What subsequently happened to interest rates and the overall stock markets? Under President Trump who’s from the Republican Party with almost the exact opposite policies and governing styles as his Democratic predecessor, President Obama, guess what happened? The 10-year treasury yield rose almost exactly 150 basis points over the next 15 months, and the S&P 500 rose 37.87% into the first quarter of 2018 Trump tax peak.

Okay. That was the overall market. You say to yourself, “Given what I’m hearing on TV, I’m sure tech stocks didn’t perform very well because interest rates were rising,” basing those beliefs on the non-stop TV networks, talking about sector rotations and growth underperforming value for the last six to nine months.

Obviously, tech stocks didn’t work back then either. Well, the data says differently. Obama round two, the NASDAQ growth index represented by the QQQ ETF rose 49% from November 2012 through the first quarter of 2014. Under President Trump with the exact opposite economic policies as President Obama, the QQQ ETF, the same ETF rose 50.68% over the period from his election in November of 2016 through the first quarter of 2018. The difference was 1%.

A similar rise in the QQQ this cycle under President Obama would put it around 400 in the first quarter of 2022. Earlier this week, it sat around 311. Now I caution trader types that the biggest part of these returns came after July 4th in each of 2013 and 2017 as big institutional investors in the market shifted their views from one year to the next year.

In fact, in both 2013 and 2017, the ETF QQQ rose over 30% from just before July 4th weekend through its peak in the first quarter of the next year. A similar gain in 10-year interest rates under Biden would put its yield at around 2.1% to 2.25% into the first quarter of 2022, hardly crippling to the economy or the markets. A similar percentage move as 2013 and 2017 during this year would put the S&P 500 around 4,500 to 4,600 in the first quarter of 2022.

Don’t say it can happen. Think about the size of the stimulus programs about to hit positively on our US economy during the second quarter through the fourth quarter this year. The magnitude of what Congress just passed this week is $1.9 trillion. The American Rescue Plan is two times larger than the December plan of $900 billion just three months ago, and hold on, that’s 10 times larger than the Trump tax cuts in 2018.

The Democratic-controlled Congress has authorized almost $1.25 trillion to be distributed over the next five months into the end of the third quarter. Think about that. To put that into context, the Trump tax cut was $700 billion over 10 years. This is 1.2 trillion to consumers in five months. You want to be short stocks on that? You want to bet on a market correction of 10% to 20% with those numbers?

About $710 billion of the $1.2 trillion will be going to US families and consumers. Seeing that over 75% of the US economy is consumer-led, it’s not hard to see them spending and saving hundreds of billions of dollars through the Christmas of this year. The personal savings rate was already over 20% during the lockdowns last year, and now we’re doubling down on those policies?

Well, I’ve been asked multiple times during the last four weeks about the turmoil in the treasury markets. Why am I not concerned or panicked about inflation right now? I keep returning to the same answer. That answer, we saw this upturn in inflation coming over a year ago. How? We saw the upturn in copper and lumber prices happening in real-time early last April in 2020. Almost exactly a year ago, when you first discussed pent-up demand in housing and auto markets caused by millennial spending.

Now, those same charts are saying that commodity inflation headwinds are starting to peak here late in the first quarter and early second quarter. How is that possible, you might ask when things are so strong? Well, it’s possible because commodity inflation starts in China as they are the incremental buyer of all commodities, much as they were in 2002 through 2007 as they were preparing for the Olympics.

During the COVID lockdowns in late first quarter of last year and early second quarter, the Chinese began hoarding and stockpiling everything their economy needs, medical equipment, copper, semiconductors, rare earth, whatever it needed, steel, you name it and their government bought it. They did so because they were terrified of riots from their citizens if they ran out of stuff. They did it because they were scared of President Trump winning reelection, and of any ongoing tariff consequences if that happened, and they did it because they’re not governed by capitalism. They don’t look at the world on a return on invested capital basis.

They knew if they did not have these things, when we solved the virus thing, our economy can’t grow. In a communist country like China, if you aren’t growing and your citizens aren’t working, you run a great risk of riots and government leaders being overthrown. They bought and they hoarded and when it comes to semiconductors, they did it right up until the end of the year, double and triple ordering and stockpiling just in case.

Now the data out of China’s peaking, they’re trying to slow their credit expansion down because they’ve made a huge number of bad loans, lending money to bad companies. Given all this, we remain very positive on risk assets for the remainder of 2021.

A topic that is briefly addressed on CNBC by market commentators almost every day is one of volatility. This is probably the topic that scares most of our clients the most as short-term price swings can be emotionally charging events, causing reactions that are better not taken.

We continue standing by our belief for 2021 that volatility is declining not rising and this will continue through the year. Why? Well, the Federal Reserve is in easing mode and the federal government is in spending mode. The forward volatility markets have declined by over 50%, 5-0 over the next 12 to 15 months post-presidential election. Spot volatility each time in 2013 and 2017 returned to below 12, and remember listeners, in 2017, it hit a historic low of 9.

Yes, lower volatility feels good to most investors. Lower volatility provides valuation expansion tailwinds for equities as it happens. It provides PE expansion almost as much as lower short-term interest rates do. Think back to 2017, the reason it was such a great year for equities is that money was flowing into stocks in anticipation of the Trump tax cuts. The economy was expanding and volatility collapsed particularly in the fourth quarter of the year in early 2018.

Well, the S&P 500 has a long way to go upward from last week’s lows through the first quarter of 2022 if we keep following the same path of money flowing into stocks and slowly out of bonds, the economy expanding on the back of the reopening and stimulus and lower buyers counts, and three, the hidden factor that no one else seems to be discussing, lower volatility, which behind the scenes, is breaking lower, not higher, as the TV pundit seem to think.

Meanwhile, real growth is now picking up, which is what I’ve been told and learned that equities, earnings, and our economies long for. Once those factories in the economy start returning to 80% to 100% capacity utilization, and once supply starts to catch up with demand, prices tend to peak. Manufacturers spend money on Capex to add capacity to meet demand. Which is a boom for the economy, a boom for earnings, and tends to dampen future inflation expectations which, as I mentioned last week, Goldman Sachs is peaking here in the upcoming month of April.

Equity investors should not fear rising long-term interest rates at these levels, particularly now that it looks like the inflation component is starting to peak after rising in late May, early June of last year. Of the 16 rising interest rate environments, the markets rallied in 13 of those cases. Rising interest rates are simply reflecting the fact the economy is recovering and vaccinations are working.

The $1.9 trillion American Rescue Plan is set to be released in about a week. It looks to provide $400 per week of unemployment insurance benefits until the end of August of this year. A $1,400 rebate checks to most individuals on the back of $600 payments granted just two months ago and more aid for vaccine distribution, School, Child Care, hard-hit industries in many local governments. Doubling the federal minimum wage to $15 an hour over four years has been thrown out.

Those programs should be good for the economy and stocks throughout most of 2021. The collateral damage caused by their rapid increase in long-term interest rates caused leveraged players to sell and to likely miss out on the positive effects of these programs. Much as these people were forced in front of the election to sell, they had to turn around and scramble back into the markets in December and January at much higher levels.

After July 4th, before Labor Day of this year, big large investors will once again be looking forward, they’ll be looking out to the second half of 2021 and all of 2022, and what are they likely to see? They’ll see very difficult comparables for the group in the value universe and reopening universe that many are now chasing very late to that party.

Moreover, they will see higher secular growth companies have stalled for a year and their valuations have compressed and now they look cheap for zero long-term growth and free cash flow profiles. Big investors who’ve been chasing and pushing up value stocks since July or September of last year will start asking themselves, “Why am I paying peak multiples and peak EPS in 2021 for these names?” They’ll start asking themselves, “Is the Federal Reserve going to raise rates in 2022, and should I be reaching for these stocks and their valuations?”

What stocks will be hurt the most if the Federal Reserve does raise short-term interest rates in 2022? Well, the value stocks. They will be reaching long-term gains in many of the cyclical names and wondering maybe they should sell some in case Biden and Congress raise taxes in 2022. When, and if the year continues to play out in its normal manner as it has for almost two years. X 3 weeks last March, the overall market should run into the second and last of its air pockets for the year. In the dead zone of the late second quarter, we would look for another down move in the overall market.

Possibly, a slightly larger percentage drawdown than from what we saw a few weeks back, but far less than a 10% correction that others seem to fling around on financial newscast. We’ll discuss these things if and when the time should present. Go ahead and keep on listening.

At Oak Harvest, we’re comprehensive long-term financial planners. What this means is that, as our client, you and your financial advisor should have a financial plan that is independent of the volatility of the stock markets. Give us a call at 281-822-1350. We are here to help you in your financial journey through life with a customized retirement planning. I’m Chris Perras, God bless, have a great weekend and enjoy spring break.

Speaker: All content contained within Oak Harvest podcast expresses the views of the speaker and is for informational purposes only. It is based on information believed to be reliable when created, but any cited data, indicators, statistics, or other sources are not guaranteed. The views and opinions expressed herein may change without notice.

Strategies and ideas discussed may not be right for you and nothing in this podcast should be considered as personalized investment, tax, or legal advice or an offer or solicitation to buy or sell securities. Indexes such as the S&P 500 are not available for direct investment and your investment results may differ when compared to an index.

Specific portfolio actions or strategies discussed will not apply to all client portfolios. Investing involves the risk of loss and past performance is not indicative of future results.