The U.S. stock market is as calm as can be on the surface,
while churning underneath more than it has in decades.
The S&P 500 is so quiet it is almost disconcerting. The
index hasn’t had a 5% correction based on closing prices since the end of
October; no wonder the new day traders who started buying shares in lockdown
think the market only goes up. The last time the S&P was this serene for so
long was in 2017, a period of calm that ended with the volatility crash early
in 2018—although back then it was even quieter for much longer.
Yet, look at the performance of types of stocks, and they
have been swinging around much more than they usually do. Investors have been
switching their bets between industries at a pace not seen outside of crises;
March brought the biggest gap between the best and worst-performing sectors
since 2002.
The link between moves in growth stocks and cheap “value”
stocks is the weakest—measured by the correlation—since 1995; investors are
using them as proxies for betting for or against economic recovery.
Meanwhile, big and small stocks last moved so independently
of each other during the dot-com bubble of 2000, never a reassuring sign.
I think this is another aspect of TINA: There Is No
Alternative to stocks. With Treasurys, corporate bonds and cash offering meager
or zero return, stocks offer the best hope of gains. Investors who would
previously have shifted money from stocks to bonds or vice versa now just
switch from one sort of stock to another—so falls in one are offset by gains in
another.
There is no guarantee that it continues this way, of course.
Bring enough fear into play and investors will bolt for the exits no matter how
low cash yields are, just as they did in March last year. But while times seem
pretty good, it is hard to justify buying a long-dated bond yielding far less
than inflation. And times do seem pretty good.
A widespread theory among those of a cautious disposition is
that stocks just keep going up because a massive bubble has been inflated by
cheap money and government stimulus. Stocks haven’t been so expensive since
2000, while a bubble mentality is obvious in the wild overtrading of
fashionable stocks. A cluster of small stocks popular with retail traders has
often featured at the top of the most-traded lists this year, notably GameStop
and AMC Entertainment but also favorites such as Virgin Galactic and BlackBerry.
It is undeniable that stocks are far more expensive than
usual. But bubbles usually involve lots of volatility as they inflate, not a
calm exterior and turmoil within, because every little price drop is magnified
by others fearful that the bubble is about to pop. In 1999 there were at least
nine drops of more than 5% in the S&P 500, and from its intraday peak in
July to the October low it fell 13%.
This time the most obvious threat to stocks is the Federal
Reserve, rather than the market’s overvaluation. If the Fed raises rates, cash
and bonds suddenly look much more attractive, and the TINA justification for
buying extraordinarily expensive stocks is undermined.
“You’ve got lots of volatility within the market but not a
lot of volatility of the market,” says Robert Buckland, chief global equity
strategist at Citigroup. “If there’s an alternative to just owning the index
that could change.”
This month’s Fed scare showed just how sensitive stock
prices are when it turns out there is an alternative to stocks, of sorts. The
Fed raised rates fractionally off the floor by offering 0.05% instead of 0% on
its cash-absorbing reverse repurchase agreements, a kind of overnight secured
deposit, and instantly sucked in $235 billion extra. Talk of rate increases
coming in two years instead of the three previously projected added to pressure
on stocks, and the S&P fell just over 2% in three days before resuming its
upward climb.
If that was the reaction to the Fed just barely doing
something close to nothing, imagine how scared the market would be if the Fed
started a normal rate hiking cycle and made cash attractive again. It isn’t
something I think is likely soon, but the number one threat that could bring
the turmoil from the depths to the surface of this market is the Fed.
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