A Summer Melt-Up in Stocks?

Fred Imbert of CNBC reports that the S&P 500 and Nasdaq hit fresh record high as Alphabet and Twitter gain on earnings:
Stocks rose on Friday after strong earnings from big tech companies such as Alphabet and Intel while the U.S. economy grew at a better-than-expected clip in the second quarter.

The S&P 500 gained 0.6% while the Nasdaq Composite climbed 1%. Both indexes reached all-time highs around midday Friday. The Dow Jones Industrial Average traded 27 points higher.

The major indexes briefly pared gains after National Economic Council Director Larry Kudlow told CNBC’s “Squawk on the Street ” he would not expect a “grand deal ” to come out of next week’s U.S.-China trade talks.

For the week, the S&P 500 and Nasdaq were headed for solid gains. The two indexes were up 1.6% and 2.2% week to date, respectively. The Dow is up 0.1% this week.

Alphabet reported better-than-expected earnings Thursday and announced a massive $25 billion share repurchase program. The results and buyback sent the stock up 10.4%.

Twitter shares gained more than 8% on the back of second-quarter results that topped estimates. The social media company also reported a 14% rise in monetizable daily active users.

Consumer stocks such as Starbucks and McDonald’s also contributed to the gains. Starbucks gained 7.1% after reporting same store-sales growth for the previous quarter that crushed estimates.

McDonald’s climbed 0.5% as promotions led better-than-expected U.S. same-store sales.
More than 40% of S&P 500 companies have reported quarterly earnings for the second quarter. Of those companies, 76.4% have posted a stronger-than-forecast profit, according to FactSet.

The U.S. economy expanded by 2.1% in the second quarter, the Commerce Department said Friday. The broadest measure of the U.S. economy was expected to come in at 1.8%, according to economists surveyed in CNBC/Moody’s Analytics Rapid Update.

Growth was driven by a 4.3% increase in consumer expenditures, which offset a 5.5% slump in business investment.

“The consumer and government spending drove all of the gain in GDP as trade, inventories and investment reversed the Q1 gains,” Peter Boockvar, chief investment officer at Bleakley Advisory Group, said in a note. “On the question that everyone tries to answer in light of the longest economic expansion on record, when will we see the next recession, I again believe it will be determined by the direction of the stock market.”

The data release comes as investors await a potential rate cut from the Federal Reserve next week. Market expectations for a 25 basis-point rate cut were at 78.6% on Friday morning, according to the CME Group’s FedWatch tool.

“The market owes its strength in large part to the Fed eases priced in. And the Fed has noted the slowdown in business resulting from the generally slower global economy,” said Steve Blitz, chief U.S. economist at TS Lombard. “The net of this is ... the Fed has no option other than to cut 25 on Wednesday and see whether the data unfold to create the need for a further cut in September. The push is to keep equities up and help the world be safe for dollar debt.”
Indeed, all eyes will be on the Fed next week and barring an unexpected surprise, a 25 basis point rate cut will be delivered on Wednesday. This morning's strong GDP report won't change the Fed's mind.

What happens next? Well, since the rate cut was already baked into equities, I expect a mild selloff to occur but CTAs and quant hedge funds will be buying any dip as their models are all bullish on stocks.

What is astounding, however, is that equities bounced back strongly after the bad Santa selloff of 2018 and they haven't really let up at all.

Year-to-date, the S&P 500 is up 21% led by tech shares which are up 33%:

And the Fed is cutting rates because inflation expectations remain stubbornly low!

If the dips continue to be bought and we get more record highs on the S&P 500, Nasdaq and Dow Jones, I suspect people are going to be worried about a good old fashion summer stock market melt-up.

In my opinion, things are heating up too much in stocks but the algos are driving them higher and higher and fundamental investors are going to end up chasing them higher or risk another year of severe underperformance.

In fact, a measure of value versus growth stocks has dropped to a multi-decade low:

Value investors are getting punished as growth stocks garner the bulk of the gains.

It certainly feels a bit like 1999-2000 and this can go on longer than most investors expect, frustrating the hell out of value investors who patiently wait for the tide to turn.

But it's not just stocks seeing big gains, all risk assets are on the rise.

Greek 10-year bond yields fell to a record low of 1.9% this week:

Although I think this makes perfect sense following the election results where the center-right New Democracy party led by Kyriakos Mitsotakis won a landslide victory.

Interestingly, you might look at the world today and think this expansion has a lot more room to go. Central banks are all dovish, tech stocks are on fire, inflation is muted, and there's no reason to worry.

Chen Zhao, Chief Global Strategist at Alpine Macro, recently wrote a comment on whether we are in a mid or late cycle, noting the following:
Since the 2008 Global Financial Crisis, the U.S. economy has been in a low-altitude expansion mode, with no apparent boom happening anywhere in the economy. Overall GDP growth has averaged 1.8% throughout the entire expansion phase, with consumer spending growing at 2.1% and private capital investment at a 3.6% annual rate.

Consumers have been reluctant to re-leverage their balance sheets, and wage gains have at most been anemic, averaging a mere 1% since 2013 after adjusting for inflation (Chart 4). Most importantly, inflation has been very low and under the Fed’s target for some 10 years, giving no excuses for tight monetary policy. In fact, last week, Fed Chair Jay Powell made clear that the central bank is ready to chop rates.

The only place that may have excessive growth is corporate leverage, which has escalated since 2014 (Chart 5). Rapid growth in debt always merits concern. Nevertheless, there is something important to be noted: The U.S. corporate sector has used debt to buy back shares in order to maximize profits, rather than to finance investment or expand its balance sheet.

Of course, no one should be complacent about the rapid change in the corporate capital structure and escalating leverage. This means that investors need to watch quality spreads closely, because any trouble in the economy will likely be signaled by a blow-up in the credit market. So far, everything has been quite calm.

The bottom line is that the U.S. is going through a mid-cycle slowdown rather than heading into outright recession. With the Fed expected to drop rates and inflation non-threatening, the cycle will likely be extended. Of course, any significant negative shock could still knock the U.S. economy into contraction, but I think that is a small-odds event.
Other market commentators share the sentiments expressed above. Jean Boivin, the Global Head of Research at BlackRock, noted this on LinkedIn today: "The dovish tilt by global central banks has led to easier financial conditions in the G3 economies. This should cushion the global slowdown and help extend the business cycle, in our view."

The consensus seems to be the Fed and other central banks will cushion any slowdown and extend the business cycle.

Of course, not everyone is in agreement with this. Bridgewater's Ray Dalio has been talking up his book stating the current era of low interest rates and quantitative easing might be coming to an end, and his answer to a new market paradigm that could see escalating conflict between capitalists and socialists is simple -- gold:
“I believe that it would be both risk-reducing and return-enhancing to consider adding gold to one’s portfolio,” the billionaire founder of investment management firm Bridgewater Associates said in a 6,000-word essay posted on LinkedIn.
Gold shares have been doing well but Ray has been bearish lately and it's costing his mega hedge fund performance. He may turn out to be right, eventually.

He's not the only smart hedge fund manager who is bearish. Greenlight Capital's David Einhorn has turned bearish on US credit:

And there are plenty of other smart investors who are bearish or sitting this rally out.

The problem is a long as stocks and other risk assets rally, the pressure will be on these investors to participate in the rally or risk severely underperforming.

I don't know, it looks like another tech melt-up is upon us but in these markets, it doesn't take much for nervous investors to head for the hills.

Still, as long as stocks and other risk assets keep rallying, supported by the Fed and other central banks, it's going to be harder and harder to beat these markets.

Keynes once remarked "markets can stay irrational longer than you can stay solvent." It might have been Gary Shilling who said it but I attribute it to Keynes. Regardless, it's a great quote, keep it in mind as we head into a summer tech melt-up.

Below, Barry Bannister, managing director and head of US equity strategy at Stifel, Alec Young, managing director of global markets research at FTSE Russell, and Lindsey Bell, investment strategist at CFRA Research, join CNBC's "Closing Bell" team to discuss what's driving markets.