Is The Rally Near an End?
A year during which the market exceeded all expectations ends not with investors backing off but rather with them throwing caution to the wind.Just buy more stocks or "BUY MOAR STAWKS!" as gung-ho traders like to say.
The trend was particularly prevalent among those who prefer index funds, as ETFs saw their second-biggest week of inflows ever at $31.4 billion, according to fund flow data from Bank of America Merrill Lynch.
Active strategies, as expressed through mutual funds, saw huge outflows, with the $22.7 billion leaving the fourth-worst week on record. However, the difference of $8.7 billion still left the equity side of the ledger with a big week.
Speculation continues to build that the bull market is running out of steam, even as the major indexes continue to set records. The Dow industrials are threatening to break 25,000 as 2017 winds to a close, with the index up just shy of 25 percent including Friday's gains as of midday. The blue chips would need to pick up just another 1.5 percent or so to break the 25K barrier.
Market strategists worry that the inflow of money could signal that the rally is getting old and finally dragging the last bears in off the sidelines, a classic capitulation sign.
"As the stock market continues to soar, it is attracting more money into stocks. That's what usually happens during melt-ups," Ed Yardeni, founder of Yardeni Research, said in a blog post Friday. "The flow-of-funds case for a melt-up is mounting as more hot money pours into equity ETFs."
BofAML's count shows that stock-focused funds — both ETFs and mutual funds — have pulled in a net $294.7 billion year to date. Excluding mutual funds, the inflows to their passive counterparts have totaled just more than $448 billion. The big shift to passive comes even though stock pickers have had a comparatively good year, with 49 percent of large-cap fund managers beating their benchmarks, according to Goldman Sachs.
The most recent surge in ETFs came from some of the $3.4 trillion industry's most popular names.
The SPDR S&P 500 Trust fund (SPY) pulled in just shy of $10 billion over the past week, the iShares S&P 500 Value ETF (IVE) gained $2.2 billion and the iShares Mid-Cap 400 Value ETF (IJJ) grabbed about $1.4 billion, according to FactSet. Year to date, the iShares Core S&P 500 (IVV) has been the big winner, with $31.6 billion in inflows as the $142.9 billion fund has returned nearly 20 percent.
While pouring money into other areas, investors last week yanked $2.2 billion out of the iShares Russell 2000 ETF (IWM), which tracks the small-cap index.
Professional investors have provided much of the enthusiasm for the market. The Investors Intelligence survey, which gauges sentiment from investing newsletter authors, has found bulls outnumbering bears at around the same level as just before Black Monday in October 1987, when the Dow lost 22 percent in a single day.
In fact, investors continue to hedge their bets, with inflows to bond funds totaling $348.1 billion this year even as performance between stocks and fixed income is at its biggest disparity on record.
It's been another great week for the stock market, people feel good, the Fed raised rates a quarter of a percentage point (25 bps), just as expected, and now that the Fed is out of the way and Republicans are sprinting to finalize a new tax plan, there's a renewed sense of optimism out there, so why not just jump on stocks, especially if a melt-up is in the works?
So, let me attempt to answer this question since people read my market comments diligently. First, in the last month I've made more money trading stocks than I did all year sitting on US long bonds (TLT).
It's not that I don't like US long bonds (TLT) or still believe they offer the best risk-adjusted returns going forward. Given my long-term fears of deflation headed to the US, I most certainly do like US long bonds and still believe they offer the best risk-adjusted retuns going forward:
At the beginning of the year, when some market commentators were telling you it's the beginning of the end for bonds, I told you to ignore them and load up.
With the tax cuts in the works, I guarantee you a whole new barrage of strategists will be on CNBC telling us to dump bonds and....you guessed it...just "BUY MOAR STAWKS!".
Why not? Look at the last 25 years. Earlier today, a buddy of mine who trades currencies was telling me that over the last 25 years, the annualized total return of the S&P 500 was 9.85% and close to 21% for Apple shares (AAPL).
These figures include the 2008 crisis. In fact, we calculated using his Bloomberg what if an average investor bought the market at the top in 2007, rode the huge 40% drawdown during 2008, and then sat on their S&P 500 shares, how well off would they be?
It turns out great, well over 100% returns, so why bother with hedge funds, mutual funds, private equity, real estate, infrastructure, or private debt, just "BUY MOAR STAWKS!" and relax, with every central bank out there backstopping equity markets, you will always come out ahead.
No wonder Passport Capital's John Burbank shut down his flagship fund because of 'unacceptable' returns and Alan Howard of Brevan Howard is having the worst year of his career. I told you back in July, macro gods are in big trouble. Central banks around the world have clipped their wings, effectively killed volatility in bonds and currencies, so how are they going to make money in this environment?
Even Stanley Druckenmiller, who boasts the best long-term record in macro investing, said he’s having a tough time this year. No kidding, they all are, this isn't an environment for big macro bets.
So, forget paying some hedge fund "guru" 2 & 20 so they can make the Forbes list of the rich and famous and buy $20 million-plus condos in Manhattan. Who needs these glorified asset gatherers charging hefty fees for not delivering alpha and underperforming cheap low-cost stock ETFs? Just "BUY MOAR STAWKS!"
Alright, it's time to get a little serious here. Last Friday, I wrote a really good market comment which most of you probably didn't bother reading, Best of All Worlds For Stocks?, where I painstakingly went over my macro thoughts, mixed them with my outlook for some market sectors, and where I warned you:
[...] as I keep warning you, stocks don't go up forever even if they can go up longer than pessimists and optimists think. There is a lot of money out there fuelling speculative frenzy, and it's coming from central banks, big trading outfits and hedge funds playing the momentum game, hoping to squeeze the very last dollar and get out in time.The Fed and other central banks are desperately trying to create another major melt-up in stocks and other risk assets which they hope will lead to a rise in inflation expectations.
The deafening silence of the VIX and bears leads many to erroneously conclude that central banks control these markets and what they say goes. The next generation of "Big Shorts" is anxiously awaiting for something, anything, to blow up (China, Eurozone, etc.) but thus far markets keep soaring higher, steamrolling over them.
Remember what I told you a long time ago, there are two big risks in these markets right now:
It might shock you to learn that it's the second risk that keeps asset managers awake at night because it forces them to chase risk assets at higher and higher levels knowing that downside risks are multiplying as asset values keep hitting record levels.
- A meltdown unlike anything we've ever seen before, making 2008 look like a walk in the park.
- A melt-up unlike anything we've ever seen before, making 1999-2000 look like a walk in the park.
In other words, if we first get a melt-up before we get the next huge meltdown, it will buy central bankers some time but ultimately, it will ensure a much longer and deeper recession, and likely lead to that prolonged debt deflation scenario I keep warning of.
So maybe it's not as good as it gets for stocks, maybe there is more "juice" left to squeeze shorts and send stocks a lot higher but the bond market isn't buying any of it and neither should you. Trade stocks but be careful, when the music stops, we will experience the worst bear market ever.
Forget this week's rate hike or plans to hike rates three more times next year, there is plenty of liquidity to drive risk assets much higher, which is why over the last month, we've seen signs of euphoria creeping back into markets.
The only problem is the bond market isn't buying any of the nonsense going on in stocks. In fact, this afternoon, I was listening to Rick Santelli on CNBC saying the yield on the 30-year US bond dropped a lot this week and the spread between the 30-year and 5-year has flattened back to pre-2008 levels just before the great recession.
I get into public and private fights with people like Garth Turner of the of The Great Fool blog who ridicules me for recommending US long bonds and for my deflation outlook (even though I'm right). Garth thinks he knows it all, just buy ETFs of the market and preferred shares, rent, don't buy, and you'll come out ahead in the long run.
To be fair, some of his advice is sound, but his inflation outlook and his outlook on rates have consistently been wrong. First of all, if you believe rates are going to soar, why buy preferred shares? Second, while I agree with Garth the Canadian housing market is cruising for a bruising, my outlook is entrenched in my deflationary scenario, meaning a severe US recession, lights out for Canada and rest of the world, new secular low for long bond yields (more negative yielding sovereign bonds), soaring unemployment, and a long bout of debt deflation.
My transmission mechanism is different and just because I see rates headed lower, doesn't mean I think real estate prices are headed a lot higher. But good old Garth doesn't understand, refuses to publish my comments or publicly ridicules me (don't care, it's his blog, let him pick and choose the comments he wants on there even if they're gibberish).
Most people don't get it. They see the economy firing on all cylinders, stock markets roaring, bond yields low, no inflation pressures, and think to themselves, why not just "BUY MOAR STAWKS!"?
As I keep warning you, enjoy the liquidity party while it lasts but pay close attention to the bond market which is signaling a slowdown ahead.
The good news is it typically takes a few rate hikes before the stock market starts pulling back meaningfully, and the risk of a melt-up is now more present than ever, but be on guard, especially when you see these type of breakouts on the S&P 500 (SPY):
Could it last into the new year? Sure it could or we can get another selloff like we did early in 2016 after the Fed hiked rates in December 2015. Who knows what will happen, they might sell the news once this tax plan is finalized.
My advice is to take the time to carefully read last week's market comment, Best of All Worlds For Stocks?, where I went over my macro thoughts, mixed them with my outlook for some market sectors. I'm getting ready to write an end-of-year comment for all of you, but it takes a lot of time going through everything and I've been very busy trading stocks lately.
Once again, hope you enjoyed this week's market comment and please remember to take the time to contribute via Pay Pal on the right-hand side under this image:
I thank all of you who take the time to donate or subscribe to my blog, I truly appreciate it.
Below, CNBC's Kelly Evans speaks with iconic investor Stanley Druckenmiller on the stock market, tax reform and his stock picks. Even though I don’t agree with everything he says, this was one of the best interviews of the year, well worth listening to.
And a leading indicator for stocks just entered a death cross, but the traditionally ominous signal might not be as scary as it's cracked up to be.
I agree, traders need to stop looking at the daily chart because when I look at the weekly chart of high yield debt (HYG), I don't see anything that worries me yet:
Having said this, read my comment on the canary in the coal mine to understand why cracks in the high yield market should be monitored carefully. Ignore the bond market at your own risk!
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