Written by: Ashley Perlmutter
As we end the second quarter, we want to take a look at where the U.S stock market is after this past year of ups and downs. Currently, the U.S. stock market is as calm as can be on the surface, while churning underneath more than it has in decades.
The S&P 500 is so quiet it’s wild. The index hasn’t had a 5% correction based on closing prices since the end of October; no wonder the new day traders who started buying shares in lockdown think the market only goes up. The last time the S&P was this serene for so long was in 2017, a period of calm that ended with the volatility crash early in 2018—although back then it was even quieter for much longer.
Yet, if you look at the performance of types of stocks, you’ll see very interesting data. Investors have been switching their bets between industries at a pace not seen outside of crises; March brought the biggest gap between the best and worst-performing sectors since 2002.
The link between moves in growth stocks and cheap “value” stocks is the weakest since 1995; investors are using them as proxies for betting for or against economic recovery. Meanwhile, big and small stocks last moved so independently of each other during the dot-com bubble of 2000, which is never a reassuring sign.
A widespread theory among those of a cautious disposition is that stocks just keep going up because a massive bubble has been inflated by cheap money and government stimulus. Stocks haven’t been so expensive since 2000, while a bubble mentality is obvious in the wild overtrading of fashionable stocks. A cluster of small stocks popular with retail traders has often featured at the top of the most-traded lists this year, notably GameStop and AMC Entertainment but also favorites such as Virgin Galactic and BlackBerry.
It is undeniable that stocks are far more expensive than usual. But bubbles usually involve lots of volatility as they inflate, not a calm exterior and turmoil within, because every little price drop is magnified by others fearful that the bubble is about to pop. In 1999 there were at least nine drops of more than 5% in the S&P 500, and from its intraday peak in July to the October low it fell 13%.
This time the most obvious threat to stocks is the Federal Reserve, rather than the market’s overvaluation. If the Fed raises rates, cash and bonds suddenly look much more attractive, and the TINA justification for buying extraordinarily expensive stocks is undermined.
This month’s Fed scare showed just how sensitive stock prices are when it turns out there is an alternative to stocks, of sorts. The Fed raised rates fractionally off the floor by offering 0.05% instead of 0% on its cash-absorbing reverse repurchase agreements, a kind of overnight secured deposit, and instantly sucked in $235 billion extra. Talk of rate increases coming in two years instead of the three previously projected added to pressure on stocks, and the S&P fell just over 2% in three days before resuming its upward climb.
It’s interesting to think about the reaction to such a small change from the Fed, allowing us think what type of reaction there will be if the Fed starts a normal rate hiking cycle and makes cash attractive again. We will continue to follow the news from the Fed and discuss how we think that will affect the economy and stocks.
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