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Welcome to the 10th edition of the Weekly Wrap, where we believe life can always be summed up with a quote from the 1983 classic Trading Places
Stock Market Investors: “Feeling Good, Louis!”
https://giphy.com/embed/5xtDarqlsEW6F7F14Fq
Stock investors are holding their heads up high these days. Strong economic fundamentals like GDP growth and manufacturing output have buoyed markets. Tax reform is in full discussion mode, which could cause stocks to further pop. Treasury yields have risen over the past week, signaling a complete risk-on environment.
A few key stats on the market’s remarkable run this past week
6: The number of consecutive S&P 500 market close record highs.
8: Number of sessions in a row the S&P 500 has been ended in positive territory.
0: Number of days ever that the VIX, Wall Street’s “Fear Index,” has closed lower than its Thursday level of 9.19.
0.87: Total index put/call ratio on the Chicago Board of Exchange, below the average of 1.03 over the past year.
If the put/call ratio is high, that means investors are buying insurance on a market drop. But traders have pared those hedges, signaling a faith that the market stays around the current levels.
Throwing caution to the market winds?
There is a lot of faith being placed in the ability of Congress to pass meaningful tax legislation. To measure how this is playing out in the market, the S&P 500 Buyback ETF (SPYB) is a good yardstick. If corporate tax reform passes, companies will presumably have more cash to throw around. Companies that have a penchant for buybacks would then have more money to repurchase shares, causing stocks to rise further.
Buyback stocks jumped ahead of the broader market after the election on anticipation of tax reform. But as the GOP agenda hit a few hurdles, these stocks fell behind the broader market. The reignition of tax reform discussions have caused the SPYB to rally over the past few weeks, however. Investors seem confident tax legislation will happen this time – or else those stocks could see a reversal of fortune.
The pattern of trading between the S&P 500 growth stocks versus value stocks has also shown that this run might be a bit overbought. Comparing iShares S&P 500 Growth ETF (IVW) and S&P 500 Value ETF (IVE), value stocks have been left in the dust since the spring. Growth stocks tend to do well when investors are bullish on the future.
The gap between growth and value isn’t as large as it was a few months ago, but its clear that pricey stocks like Netflix and Tesla have been the preferred investment over boring Coca-Cola and General Electric. But has that enthusiasm led to an overallocation to growth stocks? That gap in relative value could close quickly if things get choppy.
Fear index shows fearlessness
And finally, the VIX chart above shows a level of complacency that we’ve never seen in the markets.
- As mentioned in our Catalonia referendum discussion, the VIX has jumped to its highest levels over the past decade on European-originated crises. See: spikes in 2010, 2011, and 2015.
- If Catalonia actually does break from Spain, the fallout from that would certainly press on investors. If this emboldened other nationalist movements to follow suit – most notably in Italy – that would be downright disastrous for the European project. The Greek debt crisis would pale in comparison to a splintering of EU-member countries.
- This doesn’t even mention some of the other risks out there: North Korea, Iran, China, Brexit discussions, lack of free-trade agreement progress.
There is apparently a lot to love about the market these days, but political risk – both domestic and abroad – is still out there. Investors should tiptoe through the geopolitical minefield.
What We Wrote This Week
- “So one of two things is happening. Either the Fed’s policy has worked too well, and we are at a point where the central bank should be loosening policy. Or the market is out of sync with the Fed’s policy maneuvers.”
- “But the referendum does create larger questions. Does it embolden other separatist movements across Europe? If these movements have legs, then look for a bigger selloff of sovereign debt for other potential break-up nations (Italy chief among them) and the euro.”
Other Links and Notes
The dollars and cents cost of a recession might be really small compared to the psychological impact it has on people and communities. (Why Some Scars From the Recession May Never Vanish; Ben Casselman, New York Times)
- “There are a bunch of people who were knocked out by the recession who aren’t coming back even in the places where unemployment has fallen,” Mr. Summers said, although he said he believed there is room for further improvement in the labor market.”
Tyler Cowen argues that monetary policy is going to be less important than maintaining an independent Fed. (The Fed Needs a Savvy Politician as Its Chair; Tyler Cowen, Bloomberg View)
- “But the next time major economic volatility comes around, Fed decisions will be scrutinized and politicized like never before. This will happen in the mainstream media, on social media, and perhaps by our very own president in his tweets or offhand remarks. The key factor for any Fed leader will be the ability to maintain and project a coherent, unified voice at the Fed, so that the Fed remains an island of relative sanity in the polarized nation. This will be a problem of crisis management, but unlike Bernanke’s crisis management it will be fought first and foremost in the trenches of public opinion.”
Preaching to the choir. (I’m Fed Up With Football and Bullish on Baseball; Al Hunt, Bloomberg View)
- “I don’t know if pro football will go the way of boxing, but I’m confident that baseball is prospering as it did when Sandy Koufax and Henry Aaron stalked the diamond.”
Cover photo: Thomas Hawk (Flickr Commons)
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