Nolte Notes 3.2.21

Sign, sign, everywhere a sign. Yield is one sign that the equity markets were watching closely last week. As yields rose investors became cautious about adding to their equity exposures as there is now slowly becoming an alternative to stocks. Investors also stopped buying technology stocks as aggressively as they had been during the summer months and into early fall. Again, expectations for an economic re-opening are not only pushing yields up but stocks that will benefit from “going back to normal”. Merging has also been a favorite activity among the “SPACs”, or Specialty Acquisition Companies that are created with the express purpose of buying companies to list them directly on the US exchanges vs. going through an initial public offering. Many of these SPACs have increased in value, even though they have not yet bought another company. It is like spending two dollars to buy a dollar. Do all these signs point to the end of the 11-month rally? We will need to wait to see some more signs before making that final call.

The correction of the past two weeks has only hit the “normal” range of 3-5%, but already investors have begun panicking about the end of the rally. There are still over 70% of the stocks within the SP500 that are trading above their long-term average price. The net number of stocks rising to falling is still at a high level. Finally, the rotation to other parts of the market (other than technology) is a long-term healthy development for the market. Economically speaking, the data is decent. Retail sales continue to boom on the back of government checks sent out at the end of 2020. Real estate is doing very well due in part to historically low mortgage rates and a desire to move out of the big city as many companies are allowing working from home as a long-term proposition. Manufacturing is doing extremely well as companies work to supply all the goods that have been purchased over the past six months. There remain shortages of a variety of goods like semiconductors, that have been in high demand and supply is struggling to keep up. It is the imbalance between low supplies and higher demand that has given rise to the concern about higher inflation. So far, the reports of inflation are not (yet) high enough to warrant long-term concern.

The widening spread between short-term and long-term bond yields has been an indication of a return toward some stronger economic activity. Fed Chair Powell, in his testimony before Congress last week, reiterated their desire to keep interest rates lower for longer until the economy completely heals from COVID. Unfortunately, as we have repeated over the past six+ months, money is not going to make the economy better, until people are willing and able to go and do as they please as had been the case before the various state shutdowns. The seeds may be already sown for some unintended consequences of too much easy money for too long that will impact the financial markets in the future. For now, equities are living off the sugar high. The bond market is signaling that higher economic activity is already here and not really in need of additional stimulus. However, once the economy fully opens, many people will likely need additional aid until their prior jobs fully return.

Last week was a wild one for stocks, but in the end, saw a continuation of the rotation toward more cyclical parts of the market. There will be some corrections and short-term returns to what had been doing well, however, over the coming few years, the markets should be moving toward more cyclical companies and away from the technology favorites of the past 10 years. It is not that many of the technology companies are not good companies and have provided tremendous value to both shareholders and users alike, it is that these companies are selling at historically high multiples of earnings (and in some cases multiples of revenue) that it is unlikely for many of these company’s stock prices to continue their recent trajectory. There is a difference between buying a good company and buying a good company at a good price. Today, many good companies are selling at historically high prices to their underlying value.

The economy will continue to gradually and with many stops and starts along the way, demonstrate solid growth that should support stock prices and higher yields in the bond market. The Fed is not likely to move anytime soon and we will be watching the bond market for clues about an appropriate time to trim stock holdings.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.

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