Summer Stall for a Bull Market
Chris Perras of Oak Harvest Financial Group, a wealth management and financial advisor in Houston, Texas, shares his perspective on the markets and the “summer stall.” He also looks at how the stock market reacts to marketplace realities before economic data is released.
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Chris Perras: Hey, Happy Friday. I’m Chris Perras, Chief Investment Officer at Oak Harvest Financial Group. We are a wealth management and financial advisor here in Houston, Texas. Welcome to our May 14th weekly Stock Talk Podcast: Keeping You Connected to Your Money. Well, so it begins. A mere week after hearing calls of how Goldilocks in both the economy and stock markets and how “Sell in May and go away” was a thing of the past at new all-time highs in the S&P above 4,200, what happened was spot volatility where the VIX index rose from a low of around 17.5 to almost 29 on Wednesday.
What happened to the S&P 500? Well, it dropped from a closing high of 4,232 last week, to an intra week low of about 4,055 on Thursday. That’s a little over 4% peak to trough in about five days. As would normally happen in a bull market, well, we V-bottomed yesterday morning, Thursday morning, and promptly have rallied over 100 S&P points on short-covering, and Friday that’s today, payday, back to near 4,125, 4,135 on the S&P 500.
Well, what was the rationale and excuse de jure for this week’s increase in volatility? Well, it was a short-term spike in a few government readings on, yes, you guessed it, inflation. To computer algorithms and trend-following hedge fund momentum investors, the true detail behind these readings are meaningless. It doesn’t matter to the computers that over half of the increase in inflation number on Wednesday was used car pricing and airline ticket prices.
Well, how much of our economy and spending are around those two things? Listeners, next to none, but to these computers, it was a reason for their computers to sell and sell and sell, or to turn around and buy puts until the market reached a level where their model said, “That’s too much.” Then by the overnight session on Wednesday night, apparently, enough of these traders had gotten together on the same side of the boat and the real money and the real options traders came into the market and decided to relieve these short-term traders of almost all their profits, and we bounced back to 4,125, 4,135 almost instantaneously.
Current bond investors are pricing in more inflation and faster Federal Reserve hikes than the Federal Reserve has guided to. However, listeners, the bond market often does this. It does this often and early. More often than not, the so-called bond vigilantes are flat-out wrong. Since 2007, the Fed Funds futures market, which is the market’s best guest of forward interest rate moves by the Federal Reserve, has been on average, wrong. How wrong? By almost 55 basis points higher than actual interest rates one year later.
While this might not sound like much to someone not falling interest rates, it’s a horrific number, particularly when long-term interest rates are in the 1.75% to 2.5% range. That’s a forecasting error of 20% to 35%. Its statistical accuracy and predictability is horrible. If you mine the data, you will find the Fed Funds’ future market is an accurate and reliable prediction of future interest rates versus reality. How far out in the future? Yes, it’s good for about one to two weeks. That’s it.
The week before a Federal Reserve meeting, or maybe two weeks before, it’s an accurate and worthwhile tool in prediction. To me and to most investors, you should see that as pretty much worthless. Listeners, regardless of what you see on TV or read in the newsletter, for now, this remains a normal bull market and it is summer. During the summer, which in the stock market starts tax day in my book, when the market sells off into the week before options expiration just like it did this week, we usually see a sharp rally the subsequent five to seven trading days is the option market makers step in and strip the short term traders and short term hedgers of almost all their gains.
Once those buyers disappear, the market tends to once again drift lower over the next 2, 3, 5 weeks as volatility spikes higher again to its ultimate summer high, and the market to its ultimate summer lows. Throughout this entire time period, the market tends to rotate and find its new leadership for the second half of the year. Think back to last year and the second and third quarters, most investors on TV were gravitating heavily to technology and growth at any price stocks because they thought growth would be scarce during the COVID shutdown.
However, if an investor were to squint and look back behind the scenes, what one saw starting around July 4th last year, was that cyclical and economically sensitive stocks were being accumulated and started to gradually outperform the overall market. While industrial names like Deere and Caterpillar, or financial stocks, like Morgan Stanley or JP Morgan, aren’t as sexy as Zoom video or Peloton, these names started turning around, around July 4th weekend and then outperforming the markets by Labor Day of last year.
It should come to no one’s surprise that these cyclical sectors’ outperformance started when? Yes, it started almost exactly when the interest rate yield curve started steepening in what is called a bull steepener fashion. That is when long-term interest rates start rising faster than shorter-term rates. Oak Harvest clients can log on to our web portal and see the yield curve chart of the 10-year interest rates minus two-year interest rates on our web portal.
Yes, as you can see by this chart, this looks like it is now peaking. Yes, you heard that right. It looks like the yield curve is already starting to lose momentum. Investors, you’re thinking what does this mean to me? This would mean that those investors now chasing the reopening value trade or buying commodity-linked stocks almost a year after that trade started outperforming dramatically are very late to that trade, and would be doing so at their own peril over the remainder of 2021.
Think of the price action of solar stocks or clean energy stocks or pot and marijuana stocks since President Biden was sworn into President in late January. The conventional wisdom was long those trades, but that trade was already in the rearview mirror by the time the actual event happened. Conversely, those conventional wisdom shorts of, you need to be short defense stocks on Biden’s softer stance on China, or bank stocks on increased regulation or sell all my oil line dirty energy names on Biden’s Green New Deal, they have been some of the best groups and names since he took office.
Listeners, stocks move in advance of economic data, they move on incremental, better or worse. By the time you hear about unprecedented semiconductor demand for chips and semiconductor supply shortages causing automobile shortages due to unprecedented demand, it’s usually closer to run for the hills and protect profits short term than the idea of pyramiding and buying more of what has been working for 12 months.
In 2020, many firms cut capacity and reduced inventories expecting a long recession. Well, the Federal Reserve avoided that outcome and caused a fee bottom in both the economy and stocks. This has meant a short-term shortage in lumber, corn, copper, and steel. Many of these bottlenecks will be resolved quickly as factories and mills restart. In fact, the tree growers are getting the same price for their lumber as they did back in 2013. The inflated price you’re seeing in almost all commodities is almost purely because the supply chain mismatches between sawmills, transportation, and wholesale and retail sellers.
After July 4th, and no later than probably around Labor Day this summer, big investors will once again be looking forward. They’ll be looking at the second half of this year and all of 2022 and what are they likely to see, they’re likely going to see higher secular growth companies that peaked way back in the second and third quarter of 2020 have stalled for over a year. They’ll see that their valuations have compressed and now they look cheap versus their long term growth and free cash flow profiles.
Big investors who have been chasing and pushing up value stocks since July and September 2020 will start asking themselves, “Am I paying peak multiples for peak EPS in 2022 in these names, 6 to 12 months in advance?” We want to be ahead of that curve and not parroting the same old things others are 6 to 12 months after the trend began.
At Oak harvest, we are comprehensive wealth management and financial planning advisor located right here in Houston, Texas. Go ahead and give us a call to speak to an advisor. Hopefully, we can help you craft a financial plan that is independent of the volatility of the stock markets. Our phone number is 281-822-1350. We are here to help you on your financial journey into and through retirement with a customized retirement planning. God bless and have a great weekend. This is Chris Perras at Oak Harvest Financial Group.
Speaker 2: All content contained within Oak Harvest Podcasts 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.
Chris Perras
CFA®, CLU®, ChFC®
Chief Investment Officer, Financial Advisor
Chris is a seasoned investment professional with over 25 years of experience working with some of the most successful money management firms in the world. Chris has made it a point in his career to adapt as the market landscape changes, seeking to utilize the appropriate investment strategy for a given market environment. His transition from managing billions of dollars at the institutional level to helping individuals and families retire is guided by a desire to see first-hand the impact he is making in the lives of clients at Oak Harvest.