There has always been some truth in the old rule that the time to start selling is when the bears begin to get bullish.
I am, and always have been, an instinctive bear. Building a career in the City when one is sceptical of everything is not easy, to which those who have known me and worked with me over the past 30 or so years will attest. And yet I have been on board the risk rally that has carried us for the past few years based on the simple argument that the so-called risk-free, those generally being government bonds, have done nothing for investors in financial assets and that therefore the money flows have had to go towards equities with their concomitant dividend streams as much out of necessity as out of conviction. Whether that stance turns a bear into a bull or simply into a pragmatist is a moot point.
Then came the Trump election and with it an eye-watering stock market rally. US markets created for themselves a Goldilocks scenario of lower taxes, higher infrastructure spending and reduced regulation and off they went, buying the living daylights out of any stock that looked to be on the winning side of the new paradigm. What they have got so far is a muddled repeal and replacement of Obamacare, a string of attacks on the security services and a rumbling scandal over the depth of contacts between Russia and the Trumpists, which some are already touting as being the next Watergate. I don’t know how many out there still have the clear memories of Watergate which I do but adding “gate” to everything from Camillagate to Penelopegate has surely blunted the appreciation of the devastating impact on the US that the real Watergate affair had. If the Russia thing gains traction, which it might quite possibly do, then US stocks could be in for a prolonged period of real nastiness.
DRUB AND BASS
Yesterday saw some pretty brutal price action led by a 237.85 point or 1.14% fall in the Dow, a 29.45 point or 1.24% drop in the S&P 500, 107.7 points or 1.83% come off the Nasdaq, WTI down to a new recent low of US$47.34 per barrel and gold back on its way to US$1,250. To underline the impact and the drivers of the sell-off, all one needs to do is to look at the moves of the prime beneficiaries of the Trump Jump. Goldman Sachs tanked 3.72%, Caterpillar dropped 3.11% and JP Morgan’s share price took a 2.98% drubbing. These might just as easily be signs of a tired bull market stopping for a breather and a spot of consolidation, something every real market bull knows is needed and necessary as the end of the Trump honeymoon and the dawning of a period of deep disappointment and loss of faith and confidence.
It would be fatuous to declare one big down day to mean “the End of the World, Part One” but it is quite possible that it triggers a more meaningful pull-back. That said, Q1 earnings were good and pointing in the right direction and although US equities, along with many others, do look rich on historic valuations, they are still quite okay on a yield basis when measured against their alter egos, namely bonds. Having hit 2.63% yield just 10 days ago, the US 10 year is now back at 2.41% and lower bond yields should, on a comparative basis, continue to remain supportive to stock prices. There are therefore arguments supporting both the view that we’re going through a healthy consolidation move as there are that this is where the wheels begin to fall off.
UPTOWN FUNK
There is no discernible reason why markets should go into a full-blown funk. There are, without doubt, arguments that some of the froth of the Trump Jump needs to be blown off but, from where I’m looking, more than that is not required. Looking at the charts, that could easily call for a 1,000-1,500 point retracement on the Dow; that’s not chicken feed but it would not cause any real damage to longer-term portfolio holdings.
Daily mark to market portfolio valuations would be hit quite badly but more traditional (and unfashionable) lower of cost or market measures should be able to take a 5% or 7.5% retracement in their stride. There are arguments both ways and whether one is happy to see the markets take a bit of a breather or whether one fears the Trump Jump turning into the Trump Dump with a need to panic sell everything is a matter of taste. My own call is that until 10-year Treasury yields are north of 3.5%, equity markets should not be too much at risk.
While most are listening to what Fed officials have to say on what happens next to the Fed’s balance sheet, it was chastening to hear Eric Rosengren of the Boston Fed air his concerns about what impact an economic slowdown might have on the commercial real estate sector. He points to low capitalisation rates, which remind me of some of the pitfalls of 2007-2008. The recent emergence of Iceland from its decade of sackcloth and ashes with the concomitant lifting of exchange restrictions has been universally lauded while nobody seems to have pointed out that, by way of ZIRP and QE, the US and most of Europe have tried to keep the party going long after the punchbowl was empty. Rosengren might only be flying a kite although that is not really his style. I’d take this to be a very serious warning and one which should not be dismissed lightly. Momentum might not be with him now but future history might.
We are living in an environment where economic fundamentals and market momentum have not always been in step. Sticking with the latter has made money, believing the former has not. After yesterday’s big pullback – it’s the first time US equities have lost more than 1% in a single session in over four months – all of these questions will be asked. Caution and considered observation across all asset classes are definitely required although it seems a bit premature to be running down the street screaming in panic, hitting every bid in sight with one hand while loading up the gold with the other.