Let's Talk About Risk, Baby

Yun Li and Maggie Fitzgerald of CNBC report the Dow jumps nearly 300 points to a record high, gains 2% for the week:

U.S. stocks climbed to record levels and closed out Friday at their session highs as Wall Street wrapped up the week with solid gains amid rising reopening optimism.

The Dow Jones Industrial Average rose 297.03 points to 33,800.60, notching a record closing high. The S&P 500 gained 0.8% to 4,128.80, hitting its third straight record close. The tech-heavy Nasdaq Composite edged up 0.5% to 13,900.19.

Stocks linked to the recovering economy led the gains again amid the accelerating vaccine rollout. Carnival Corp rose 2.6% after getting two upgrades on Wall street amid pent-up demand and potential summer restart. General Electric climbed more than 1%. JPMorgan added 0.8%.

The blue-chip Dow climbed 2% this week, while the S&P 500 gained about 2.7%, posting its best week since early February. The Nasdaq rallied 3.1% over the same period as major technology names outperformed. Apple jumped more than 8% this week, while Amazon and Alphabet both gained more than 6%.

On the data front, the producer price index, which measures wholesale price inflation, jumped in March. The March PPI data showed a rise of 1.0%, compared with a projected increase of 0.4% from economists surveyed by Dow Jones.

Year over year, the PPI surged 4.2%, which marks the largest annual gain in more than nine years.

“Inflation in the pipeline keeps heating up,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group. “We’ll see to what extent companies are beginning to pass this on to consumers next week with CPI. From what I’m hearing from companies, that process is just beginning.”

The 10-year Treasury yield ticked slightly higher to 1.66% following the inflation data. Treasury yields had retreated earlier this week from their recent highs.

Market volatility has declined significantly as the S&P 500 kept grinding higher to refresh its record high. The Cboe Volatility Index, known as the VIX, has been trading under the 20 threshold for eight sessions straight. The index looks at prices of options on the S&P 500 to track the level of fear on Wall Street. The VIX fell under 17 Friday.

“Contrary to headlines, rising interest rates, healthy levels of inflation, and an eventual Fed rate hike are not necessarily market negatives,” Larry Adam, chief investment officer at Raymond James, said in a note. “In fact, the annualized performance for the S&P 500 has been above average under each of these dynamics as long as economic growth remains robust — which we believe will occur.”

Investors largely shrugged off an unexpected jump in jobless claims from last week. The Labor Department reported first-time claims for the week ended April 3 totaled 744,000, well above the expectation for 694,000 from economists surveyed by Dow Jones.

Federal Reserve Chairman Jerome Powell called the recovery from the pandemic “uneven” on Thursday, signaling a more robust recovery is needed.

Alright, it was another solid week for stocks led by gains in the technology sector:

The S&P Information Technology sector (XLK) led the way, gaining 4.7% followed by Consumer Discretionary (XLY) which has Amazon as its top holding (22%).

In fact, this week, the S&P Technology ETF (XLK) which is made up 40% of Apple and Microsoft made a record new high:

And the short-term charts on Apple (AAPL) and Microsoft (MSFT) remain bullish even if they're a bit overbought, so this tech momentum can continue: 

Of course, it's not just Apple and Microsoft, it's a broader tech rally led by tech mega caps like Amazon, Facebook, Google and even the hyper-growth ARK stocks, all of which spurred a strong rally in the Nasdaq-100 ETF (QQQ):

So what's going on, why are tech shares leading this rally again?

I have several theories:

  • Tech shares languished in March. As we ended the quarter, I believe elite hedge funds took some profits in cyclicals (financials, energy, industrials) which did very well in Q1 to add to their tech holdings (data will be made public on May 15th).
  • COVID variants are wreaking havoc in the US and around the world. A defensive strategy is to go back into big tech stocks, like big funds did at the end of Q1 last year.
  • We are in a low growth/ low rate world, there's a premium being placed on growth in private markets and in public markets.
  • Earning season is about to get underway and and many analysts are expecting this to be a positive catalyst for stocks.
  • Lastly, the Fed reiterated this week that it will remain on the sidelines for a lot longer, focusing on its employment mandate and maintaining that inflation pressures are only transitory. Fed Chairman Jerome Powell will appear on “60 Minutes,” kicking off another week busy with Fed speakers.

For all these reasons, the bulls are bullish and to be honest, the path of least resistance is to just buy tech shares here knowing they have momentum on their side

A familiar refrain in markets is "buy the breakout", if stocks are making a record high, keep buying them.

And investors around the world have been buying global equities in droves recently:

In fact, inflows in global equities over the past five months have exceeded inflows over the last 12 years.

I know, with rates at record lows, there is no alternative (TINA) and investors are gripped with fear of missing out (FOMO).

Mix in there the new army of day traders this pandemic has created and elite hedge funds pumping and dumping all sorts of stocks, and you quickly realize why stocks garner all the attention.

But I'm reminded of what Doug Pearce, BCI's former CEO, once told me: "Risk management is most important when everything is going well."

With assets ripping higher and higher as everyone chases yield, you need to be cognizant of mounting risks.

Like what? Like how much leverage is being used to drive asset prices higher and higher and what happens if something goes wrong?

For example, we all know what happened at Archegos, but think bigger, a lot bigger!

I'm convinced elite hedge funds leveraged their "long small caps trade" (IWM) to the tilt:

I can't prove it but I know for a fact they all went short small caps/ long big tech when the pandemic first hit and then quickly reversed course to go long both, leveraging both trades as much as possible.

Leverage has a bigger impact on small caps and you can see it in the chart above, they have rallied well above their pre-pandemic levels.

If I'm a risk manager, I'm paying close attention to small caps, including small cap value stocks (not just growth) because they're the most vulnerable here to a major correction.

What else? Reuters reports that someone made a big $40 million options trade betting on a near-term stock market tumble:

A massive trade in the U.S. options market on Thursday appears to be betting that the calm enveloping U.S. stocks in recent weeks will give way to a big rise in volatility over the next three months.

One or more traders laid out a roughly $40 million bet that the Cboe Volatility Index - often called Wall Street's fear gauge - will break above the 25 level and rise towards 40 by mid-July, trading data showed Thursday.

The VIX closed at 16.95 on Thursday, its lowest close since February 20, 2020, just before the coronavirus pandemic spooked investors and roiled global financial markets.

Some 200,000 of the VIX July 25 - 40 call spread traded over the course of two hours on Thursday, starting at 10 a.m. The trades made up about a third of the average daily trading volume in VIX options, according to Trade Alert.

The trades involved the purchase of the spread's lower strike calls for an average price of about $3.37, partly funded through the sale of the higher strike calls at about $1.30 per contract.

For the trade to be profitable, the VIX would need to rise above 25 by mid-July.

Given that big rallies in the options-based index tend to come during turbulent periods for stocks, the trade could represent a bearish outlook for equities.

The S&P 500 closed at a record high on Thursday helped by a rise in technology and other growth stocks

To be sure, this trade might not be directional, it might be part of a big hedging strategy of a large fund that is very long the market, but it gives you an idea of how nervous big investors are here.

I'm also paying close attention to last year's darlings struggling in this market, like Tesla (TSLA), NIO (NIO), solar (TAN), biotech (XBI) and of course, ARK Innovation (ARKK) and Chinese internet (KWEB) stocks:


And even today, I noticed fubo TV (FUBO) was rallying hard this morning and posted this on Linkedin at noon:

"fubo TV (FUBO) up big today as it gets exclusive streaming rights to the Qatar World Cup 2022. Stock is recovering a bit after a big drop over last three months but I did notice the top holders as of end of Q4 2020 are all the prime brokers involved in the Archegos fallout. Just pointing that out"

FUBO shares closed up 13% on massive volume, off their high and they are still well off their 52-week high. When I see all the same prime brokers that helped Archegos lever itself up to insanity as top holders of this stock, I get nervous (it might be a coincidence but this stock is hyper volatile).

Now, so what? Who cares about last year's darlings? As long as the FAANG stocks and tech stocks in general keep grinding higher, as long as banks keep going up, the overall market is just fine.

True, and let me be clear, the path of least resistance in the near term is to bet on stocks making new record highs led by technology shares.

But the purpose of this comment, as stated in the title, is to talk about risks in this record setting market.

On that note, enjoy your weekend, don't worry, Fed Chair Jerome Powell will say something nice on "60 Minutes" to ramp up futures by Monday's open.

Below, CNBC's "Halftime Report" team discusses the economic outlook, markets and more with Mark Yusko, CEO and CIO of Morgan Creek Capital.

Listen carefully to Yusko, he's not a cheerleader, he's someone who understands very well that liquidity drove these markets up to dizzying highs and that the recovery won't be as strong as everyone expects. 

I also embedded the Salt-N-Pepa song that inspired me to write this comment (time just flies by!). Enjoy the music as long as it plays but just remember, when the music stops, these markets are going to get clobbered again.