Santa Shops Early

Join Chris Perras for the 11/20/2020 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 weekly Stock Talk Podcast: Keeping You Connected to Your Money. We hit a new all-time high in the S&P 500 on Monday, November 9th, and then again on Monday, November 16, near 3,625 on the back of surprising timing of positive Pfizer vaccine news, and then some more positive vaccine news from Moderna earlier this week. This caused a brief short squeeze in negatively positioned portfolios.

As of this morning, we were sitting near 3,555, 3,575, thereabouts on the S&P 500. That’s about 1% below early September’s closing all-time high. This week’s podcast is titled, By the Dip, Santa Shops Early. The election results are in and while Vice President Biden looks like the winner, the vote is being contested by President Trump and his team of lawyers are dragging out the process.

I know this concerns some of our clients and many of my listeners. As far as the market is concerned, the election event risk peaked in advance of the election around October 28th or 30th, just as the options market had said it would all year, and as we discussed for many months prior to the election. The contended states will be finalizing their results through December 1st. For those of you wanting the exact timing, well, Nevada is the next state with certification scheduled to take place on Tuesday, November 24th, but the final key deadlines are after Thanksgiving with Arizona on November 30th, Wisconsin on December 1st.

Then guess what happens on December 8th? Well, that’s the safe-harbor deadline that all states should be certified by then. Why is this of note? Well, because this timeline is laid out by the options market behind the scenes all year, continues to say that if you miss the pre-election weakness buy time period, the final pivot up for stocks for the end of the year for that Santa Claus rally and that normally strong fourth quarter and first quarter returns should start shortly. That rally should gain speed on or around December 1st through December 9th.

Why? Probably because options market makers in the broad market averages like the broad S&P 500, which are amazingly efficient markets, are probably the best pricers of risk in the world. The cost of insuring a portfolio against overall market declines, well, that peaks on or around the second week of December, between December 7th and 9th, and remains pretty much flat for the next six months. This was the exact same setup in the market for late October. It had a buy-in-the-market pre-election all year, and we know what happened starting the end of October.

What happened? The S&P 500 went from a closing low of 3,270 to a closing high of 3,625 in less than three weeks on November 16th. That’s 350 S&P points in three weeks. To think that the S&P 500 can’t rise another 350 points over the most bullish time of the year, say over six months, as volatility were to drop back to pre-COVID levels, would be saying the four most dangerous words in the investment business. This time, it’s different.

Can a similar move happen come December? Can Santa Claus really bring us a year-end rally? While there are no guarantees in the stock market, It most certainly can. Why? I’m going to list the reasons both quantifiable and unquantifiable. First, timeline-wise. Election uncertainty, which has kept hundreds of billions if not trillions of dollars or more on the sidelines the last nine months, and millions of baby boomers frozen and unwilling to make new or follow-on investment decisions in their accounts should be over.

We gave you the certification timeline a little earlier in this call. Those uncertainties should be over no later than Tuesday, December 8th. Why then? Well, that’s the safe-harbor deadline in the Electoral College for certifying election results without congressional involvement. This certification should add certainties in the markets by way of policy certainty. As uncertainties drop, volatilities tend to drop and markets tend to rise. This is great for absolute dollars, but, listeners, it’s bad for incremental percent returns.

What do I mean? I’ll repeat this rule for the rest of my investment career. The biggest percent returns are made investing in markets when volatility is high, not when volatility is calm and the markets are already trending higher. I know it feels great when markets are green every week. However, your realized percent return is likely to be far lower than had you invested additional money when things were uncertain and volatility was very high.

Come December, almost all large institutional tax selling causing additional pressure on the market by way of additional supply should be over. Why? Because those institutions’ tax years generally end at the end of September through the end of November. Most of them have already made moves for taxes prior to them closing their books, and come December 1st, a lot of short-term trading around retail tax-loss harvesting ends because the 30-day wash sale rule comes into effect for the rest of the year. All that less selling equals lower supply, which is good for stock prices.

Moreover, timing-wise, many wealthy individuals who own lots of stocks with concentrated stock positions most likely already sold stocks in advance of the election as many people were concerned that a blue wave by Democrats in November would have raised the likelihood of much higher individual tax rates in 2021. With the House of Representatives still being controlled by Democrats, but only marginally so, and the Senate most likely going to re be remained controlled by Republicans, it is highly unlikely that significant tax policy changes will be made in 2021 in the midst of a pandemic and economic weakness.

Recall listeners, it took both a Democratic president and Democratic-controlled House and Senate to barely pass Obamacare. Likewise, it took a Republican presidency and both Republican-controlled Senate and House to pass the tax reform bill in February 2018. We will most likely have a split government for the next two years. Conservatives, we should exhale. Liberals are unlikely to get many things on their Christmas wishlist for 2020 and 2021. If the 2020 election results tell us anything if they are a leading indicator for future elections, they should tell us where the base of America stands, which I believe is they tell us that the elections for 2022 can actually give us a big red wave in the midterm political elections.

Back to the current markets. We are approaching more positive seasonal market tendencies that begin earlier than most analysts on TV will discuss. They include the following catalysts. Come December, many analysts will move their valuation targets on stocks out to the second half of 2021 and 2022. In doing so, they are almost always going to lift their targets when things are good. There are billions of dollars invested in stocks that are mechanically invested based on target price changes or earnings revisions, both good and bad. Positive earnings, revisions, positive target price increases like we are currently having tend to drive stock prices up.

In good years in the markets like this many institutions get year-end money flows. What do they do with that money? Do they go searching for new ideas in December? Do they let the cash buildup and let it sit idly? No listeners, they almost never do either of those things. Every index fund manager buys exactly what they already own, regardless of price. That’s the model of index funds. As we have discussed many times, they are price agnostic on what they buy and sell. Price is irrelevant to them in both ways, buying and selling.

When money flow comes into an index fund, like on a payday, when money flows from your paycheck go directly to your 401k plan, what happens? What do the portfolio managers at Vanguard and BlackRock do? Well, as Mr. Miyagi said in the Karate Kid movie, they wax on. If shareholders redeem shares, what do those portfolio managers do? They sell, regardless of the price, they wax off. ETFs, while having a little bit more flexibility than index funds, are pretty much the same animal. Money comes into the funds, into the ETFs, they create more shares, they buy more stocks, they wax on.

Besides the election being wrapped up, which should help lower stress and volatility in the markets, volatility normally declines in late November and December because of the calendar itself. What do I mean? I mean, think about how many long holiday weekends and slow business weeks, there are the next three months. There’s Thanksgiving week, Christmas week, and New Year’s holiday.

While it doesn’t sound like a big deal, it is to the markets and options traders. Why? Well, when you buy or sell an option, you’re paying for insurance, whether the markets are opened or not. They’re priced for risk every day of the week. If you buy a put that includes protecting yourself through the end of the year, right now as a hedge to the great year you’re having for your performance, you won’t be having to pay for a lot of dead time in the market.

Yes, options market makers don’t give you a free ride on all those holidays that are coming up when the markets are closed, they make you pay for those days, even though the markets are closed, just in case. In doing so, more often than not, this causes the buyer of a put option to overpay for the actual risk that a negative event can happen. Statistically speaking, is it any more likely that a negative event happens on a holiday when the market is closed versus a day when the market is open? Historically, not at all, but options market makers make you pay for it.

This extra time decay premium is a very powerful tool when people are under-invested or negatively positioned or hedged to protect their year-to-date gains. This hedging actually can act as a backstop on market sell-offs and can lend itself to help [unintelligible 00:11:27] stocks higher throughout your end during good years like 2020 has been. This year, we will have another positive catalyst in December and January. That catalyst is stimulus. While many investors have been disappointed that a second COVID fiscal stimulus program has yet to be agreed upon in Washington D.C., the team at Oak Harvest has continued to message that it was not an if or how much the stimulus program would be, but it’s a when the program will be.

Well, now we have a little bit better idea of when. It’s likely to be early December or January in the first quarter. What will any fiscal stimulus do? Well, it will pyramid additional positive dollars into the economy on top of the Federal Reserve’s monetary QE5 stimulus that is just beginning, as well as the economic reopening that should gain momentum throughout 2021. These are positive things for equities. How about COVID? To be positive on the markets through the winter, we must have cured COVID. We obviously must have cured the virus given the stock markets are near all-time highs.

No, listeners, of course, we haven’t cured COVID. The COVID virus has ramped up again in a very horrible way across much of America. However, earlier this week, we got more positive vaccine news from Moderna. Moreover, just this week, Fundstrat, who is early to calling the stock market and economic turns in the markets way back in March because they base their predictions largely on their real data, and currently, they’re looking at real-time COVID data, well, they released a piece of research yesterday showing that there’s a very early peak in this third wave of the COVID virus.

The daily change, they look at the seven-day change, is now about 19,500 cases. That’s the lowest it’s been in nearly three weeks. It actually peaked, November 7th, as additional case rate acceleration back then was over 43,000 cases. You may ask, “How does an investor read this number positively with all the hospitalizations and news coverage of negative virus events?” All those lockdowns in Europe and everything that’s going on. Last night, California curfew. Well, that gets back to how the financial markets work. They tend to work on a momentum basis.

While this is a bad number for society in increasing in cases is still bad, it is less bad. It’s decelerating. As far as the virus goes versus its effect on financial markets, decelerating virus is a good thing, whether it’s because of newly imposed restrictions which the stock market dislikes, or through increasingly cautious human behavior, which the financial markets would rather be the reason, the end result is what we’re interested in. Slower spread in the virus is good. Peak spread is what we’re looking for. Listeners, regardless of what’s on TV, the data says that that is already behind us. We are on the down curve of new infections, which is positive.

Finally, for all my math engineering and stock market historian listeners, I give you a little data. The late Marty Zweig, who is thought of as one of the best and earliest market historians and technicians, developed a lot of trading signals over his life. The market Breadth Thrust signal has been one of his best and most historically accurate predictors of future stock market returns.

Since 1950, that’s over 70 years of data, the market has only seen this predictor over 1.85 times, 23 times. That’s less than once every three years. Well, this indicator just went over 1.85, for the 24th time in 70 years on November 19th. Listeners, there are no guarantees in trading or in the stock market, but being an engineer and a math geek and historian myself, I figured I had to share with you these historical results.

What are the results? Those results, the prior 23 times this indicator has been over 1.85 the last 70 years. Over the next six months, the average gain in the stock market was 13.5% with only one incident when returns were negative. More importantly, the average maximum drawdown during the move, during that six months, was less than 2%. Those numbers aren’t fake news. It’s just data from history. It’s historical data. While there are no guarantees, it does seem to line up with what the team at Oak Harvest has been consistently messaging for the last six months.

The fourth quarter of 2020 through the first half of 2021 should show an accelerating stock return with a market-making and sustaining [unintelligible 00:16:36] new all-time highs. There are many doubters out there, many doubters remain. They’re waiting on the sky to clear perfectly. They’re waiting on the election results to be finalized or they’re waiting on the inauguration in late January. Maybe they’re waiting on a vaccine to be implemented and shipped, not just announced by the press, or they’re waiting on a guaranteed fiscal stimulus program. It’s dollar figure and its timing.

Listeners, this is hundreds of billions of potential investment dollars remaining on the sidelines frozen. That is a positive thing for investors already in motion, adding risk, the last six months. Listeners, we are trying to keep you ahead of the curve. We’re trying to help you see what might be around the corner before others do, or give you some answers to questions even before they’re asked. Hopefully, we’re helping educate you in advance of what you might hear on the TV news networks or in your social network feeds.

Where does that leave us now? We’re in a bull market, one that should be reaccelerating up soon. Election-wise, economy-wise, calendar-wise, the risk window should be closed into early December. What should emerge on the other side is an upward trending market at new all-time highs.

Remember way back when volatility was so low it looked like fake data or fake news, the VIX at its normal minimum of 12 to 12.5. Heck, during the ultra-calm days of 2017, the VIX traded at 8 to 10. Currently, future volatility levels are 26. Remember the days of 2017, it was only three years ago, but remember when you longed for a pullback and stocks to buy, a correction of 10% that you said we wanted because you wanted to invest in some stock way back then, three years ago? The 10% pullback you wish for never came because the most the market dropped back then was about 2% from its peak to trough?

Remember way back then, it wouldn’t give you a buying opportunity. The S&P 500 closed 2017 at around 2,675. Now, November 2020, with a hotly contested presidential election somewhat behind us, and with COVID virus interrupting a ten-year expansion, the S&P 500 sits near a new weekly closing all-time high of almost 3,575. That’s not bad for three years of turmoil, including this year. It’s almost exactly 10% per year compounded return. That’s a bull market. That’s what a stimulated market and consistent government policies can look like.

Listeners, please don’t let the election results, when finalized, become an emotional event or crusade that drives your financial behavior. This event is another event in time whose outcome we can’t control. Each election period since the great financial crisis in 2008 and 2009 has shown similar patterns and stocks into and out of, each election. The markets and economy showed similar responses post-election.

At Oak Harvest, we are a comprehensive long-term financial planner. What this means is that as our client, you and your advisor should have a financial plan that is independent of the volatility of the stock markets. Go ahead and give us a call at 281-822-1350. We are here to help you on your financial journey in retirement through customized retirement planning. Many blessings and have a great weekend. This is Chris Perras.

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Speaker 2: The preceding content 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, statistics, and sources are not guaranteed. Content ideas and strategies discussed may not be right for your personal situation and should not be considered as personalized investment, tax, or legal advice, or an offer, or solicitation to buy or sell securities. Investing involves the risk of loss and past performance does not guarantee future results.