Stocks fell yesterday with the declines accelerating as the afternoon wore on. Bond prices rose, sending yields down slightly.
I have talked about times in the market when there isn’t much news. Right now, as the first quarter is coming to an end, is such a time. Treasury Secretary Janet Yellen and Fed Chair Jerome Powell spent the last two days talking to Congress. They didn’t create news. That is a good sign. More often than not, Congressional testimony yields statements that can spook investors. Thus, we will chalk up yesterday’s decline to a simple case of profit-taking.
But in a news vacuum, there usually isn’t a catalyst to move stocks higher unless it’s momentum. Right now, after a 5-10% rise so far this year on top of big gains since the depths of the pandemic, momentum seems to be exhausting itself. The FANG names mostly topped out late last summer. The speculative SPACs and other IPOs also seem to be losing momentum. The leadership mantel had been taken over by stocks most hurt by the pandemic. But financials, hotels, airlines and cruise ship stocks were among the worst performers yesterday. Momentum there seems to be running out as well, if only for a moment. Small cap stocks yesterday had their worst day in months. After the market closed, GameStop announced earnings in line with expectations, but suggested it might seek to sell additional stock. While its shares fell 14% on the news, why shouldn’t it sell stock at these inflated prices? The only serious question is why didn’t it do so sooner when its stock price was even higher?
Without momentum in sectors that have been leading the market higher, the obvious question is what will be the next accelerant. The logical answer is earnings growth, but earnings season is still 3-4 weeks away. That provides a setup for caution. There doesn’t have to be a correction in the coming days or weeks. But a good short-term flush wouldn’t be a surprise.
There is one other ingredient for a mini-correction. We are now over a year from the pandemic-induced market bottom last March. Those who took advantage of the bottom are now long-term and can start to sell at a lower tax rate.
Life is never that simple, and I am not predicting a correction imminently. But I am suggesting the ingredients are there. Note that yesterday’s drop happened on a day when bond yields fell. So far this year, to the extent that there have been any significant down days, most have related to a spike in rates. After a rise of over 80 basis points in 10-year Treasury yields so far this year, with few signs of rising core inflation, it could be argued that the bond market selling may be pausing, at least until the impact caused by spending all those stimulus checks works through the system.
The market isn’t cheap, particularly if you are expecting a sharper than consensus rise in interest rates. I will leave interest rate predictions to others. The farthest I will go is to suggest I think the future path is higher, not lower, not that bold of a prediction when the Fed is putting temporary and unnatural downward pressure on rates. As noted, since late last year, 2021 will be a tug of war between the tailwind of higher earnings and the headwind of higher rates. We all know in nature that winds don’t blow at a constant speed. The same holds for stocks. Nothing moves in a straight line. Occasional trend reversals are healthy. They create bargains and flush out week hands. With the stimulus checks in the mail, one suggests a part of that money will find its way into stocks. Certainly, if speculative momentum is higher, that is quite possible. Who knows?
But saying the market isn’t cheap doesn’t mean it’s expensive. Certainly, there is froth around the edges, but even that is dying down a bit. It all comes down to the clash of the two opposing forces. On balance, a good case can be made that the power of fiscal and monetary policy on earnings will be greater than the gathering inflationary forces. The spikes in commodity prices should be transitory. High prices beget more supply. Shortages won’t disappear overnight but they will dissipate. There are still few signs of meaningful acceleration in wages. Apartments and office space are plentiful. Those who remember the 1970s fear a repeat, while those under 40 have never experienced inflation to any meaningful extent. Memories can play tricks. Rapid inflation requires a long buildup, something that is barely beginning. 10-year Treasuries can get back to 3% rather quickly, meaning months, not years. But sustained inflation of 3% or more will take years to develop.
Thus, near term, meaning over the next couple of weeks, a bit of caution may be reasonable. But once earnings season starts, I think the bulls will regain control and stocks should move higher.
Today, Jessica Chastain is 44. Peyton Manning turns 45. Jim Parsons is 48.
James M. Meyer, CFA 610-260-2220