Get Ready For a Bubble in Stocks?

John Melloy of CNBC reports, Ray Dalio, manager of the world's biggest hedge fund, lowers his odds of a recession:

After seeing a "significant risk" of a recession only a month ago, the manager of the world's largest hedge fund has lowered his odds of an economic downturn, now that the Federal Reserve has pivoted to a more accommodating posture.

"While I still expect that there will be a significant slowing of growth in the US and most other countries, I have lowered my odds of a US recession coming prior to the US presidential election to about 35 percent," Bridgewater Associate's Ray Dalio said Thursday in a blog post on LinkedIn. "Because the markets weakened and Fed officials now see that the economy and inflation are weak there has been a shift to an easier stance by the Fed. Similarly, because of weaker markets, economies, and inflation rates in other countries, other central banks have also become more inclined to ease, though they have less room to ease than the Fed."

On Jan. 22, Dalio told CNBC from the World Economic Forum in Davos, Switzerland that he saw a "significant risk" of a recession before 2020. "Where we are in the later [economic] cycle and the inability of central banks to ease as much, that's the cauldron that will define 2019 and 2020," the co-CIO and co-chairman of Bridgewater said then.

But at the end of January, the Fed said it would take a "patient" approach to rates this year, appeasing investors who thought it was raising rates on autopilot and not listening to weakening financial conditions. Fed chief Jerome Powell said Wednesday the central bank could end its balance sheet unwind — which many traders believe is a de facto monetary tightening — as soon as this year. Powell said an announcement would be coming soon.

"While the Fed probably doesn't have enough firepower to offset a deep recession, the big sag that we expect is probably manageable," said Dalio, whose hedge fund manages about $160 billion. "More specifically, the Fed now has 250bps of easing (which will be more impactful than typical because of the longer durations of assets this cycle), plus the ability to turn QE back on, which we estimate is roughly equivalent to the 4% to 5% of easing typically required to get out of recessions."

The stock market has rebounded this year on the Fed's tack with the S&P 500 up 11 percent so far in 2019.

Bridgewater's flagship Pure Alpha fund returned 14.6 percent last year, topping the market and most of its peers. Over three decades, the fund has generated an average annual return of 12 percent after fees.

No doubt about it, Bridgewater earned its place as the best hedge fund in the world in 2018 and they have been producing stellar returns over many years.

Is Ray Dalio right to change his tune in terms of a recession hitting the US economy prior to the next election? I believe so, right now, the US economy and stock market are flying high, and it seems like fears of a global recession are dissipating fast.

Nicky Manoleas, BCA Research's Chief Operating Officer, posted this on LinkedIn (click on image):

Caroline Miller, BCA's Chief Global Strategist is one smart lady, I would take the time to listen to her webcast which took place on February 27th.

My gauge of a global recovery is simple, I just look at emerging markets stocks (EEM) and they seem to be doing fine ever since the Fed backtracked and became more dovish following the bad Santa selloff of 2018 (click on image):

If you look at the US stock market, it's enjoying its greatest two-month run since 1999 and the S&P 500 closed above key 2,800 level for the first time since November and is on the verge of making a new high if this continues (click on image):

Now, if you hear strategists on CNBC, they tell you to be careful because this is all "multiple expansion" (a fancy way of saying price appreciation) in the face of an "earnings recession".

In other words, this rally is all driven by sentiment and has nothing to do with fundamentals but what these strategists don't tell you is oftentimes by the time fundamentals shift, the big part of the rally has already taken place.

My own view is following a disastrous Q4, it was a time to make stocks great again, and the world's most influential allocators stepped in and rebalanced their portfolios into equities. When the Fed hit the pause button, they bought more equities.

Now we are at a point where people are wondering, with the Fed out of the way, for now at least, are we going to have another bubble in stocks like 1999?

As it stands, I wouldn't get too carried away but have a look at the year-to-date performance of the S&P500 sectors (click on image):

As you can see, the S&P 500 is up close to 12% and the leading sectors are cyclical sectors like Industrials (XLI) and Energy (XLE), followed by Technology (XLK) and Consumer Discretionary (XLY).

Conversely, the lagging sectors are defensive like Consumer Staples (XLP), Utilities (XLU) and Healthcare (XLV).

Importantly, if we are at the late stages of an economic rally, this isn't what you should be seeing, so either the stock market is high on cannabis stocks or the bond market has it all wrong.

But if you look at US long bond prices (TLT), they're rolling over here as yields back up (click on image):

Again, this isn't indicative of a global slowdown, quite the opposite, so maybe there is a renewed economic uptrend taking place.

Or maybe not, it could be just another buying opportunity for bonds and come the end of Q1 at the end of March, if we don't get any clear signs of a trade deal with China, I'm willing to bet the world's most influential allocators are going to rebalance yet again but this time take money out of stocks and into bonds.

It won't be a major rebalancing but enough to stall this impressive rally in stocks, so don't get too excited, nothing goes up in a straight line.

Having said this, if you look at individual stocks, you will see some of the best-perfoming stocks thus far this year are up in a huge way (click on image):

A lot of these are biotech stocks you never heard of and if you don't follow biotech closely, for sure you never heard of them.

But have a look at the biotech ETF (XBI), it's been on fire lately with no signs of slowing down (click on image):

If this thing continues to make new highs, watch out, we could have ourselves a nice biotech bubble this year.

I'm not kidding, check out some of the top-performing stocks this week, there are quite a few biotech shares in the list but there are also other stocks which momos (momentum chasers) love to chase (click on image):

And there are some biotech stocks which are not part of this list which I'm tracking closely this week (click on image):

The fist one, Amarin (AMRN) is up more than 600% in six months and it has all the top biotech funds -- Baker Brothers, Perceptive, etc. -- and Steve Cohen's Point 72 and Millenium as part of its top institutional investors (click on images) :

The second one, Clovis Oncology (CLVS) is on my watch ever since Tesaro got bought out late last year (click on image):

And the third one, Solid Biosciences (SLDB) is an interesting biotech because ever since it got killed last month, it has been staging an impressive comeback on no news (click on image):

Again, among the top holders, you'll find Perceptive, Baker Brothers and other top biotech funds but one look at that chart will scare the bejesus out of any rational investor!!

Still, this is where the big money is being made in stocks and it shows you RISK ON markets are alive and well, thriving as long as the Fed stays away.

But not all biotechs are surging higher. Bill Miller's "favorite biotech", Intrexon (XON), took a beating today, down 37%, but I'm sure someone will be buying this big dip too (click on image):

Just not me, I'm watching the biotech action from the sidelines and wondering if another bubble is forming there but I'm not chasing these hot stocks, not very confident that this RISK ON rally has legs.

It probably does but if you want to play hot biotech or other stocks, just get ready to be burned, and it can come from left field.

And even though the Fed is out of the way, it raised rates a cumulative nine times, there are certain sectors of the economy like housing that remain weak, so you can hardly say everything looks great, it doesn't. Some argue the Fed hasn't done anything yet and the economic slowdown is just getting started.

These could all just be powerful countertrend rallies and when the tide turns, everything will collapse but for now, the old adage, don't fight the Fed, is in play and this Fed isn't fighting the stock market.

Hope you all enjoyed this comment and all my comments this week, as always, please remember to kindly donate/ subscribe to this blog on the right-hand side using the PayPal options to show your financial support. I thank all of you who take the time to contribute, it's greatly appreciated.

Below, Milton Berg, the founder and CEO of M.B. Advisors, joined "Squawk Box" earlier this week to give his market calls and explained why he thinks we're in a new extended bull market and won't retest the December lows. Berg worked for Soros and Druckenmiller and he has an exceptional track record.

I hope he's right but I remain cautious and think now is the time to be extra vigilant, especially if a bubble in stocks is forming.