Economy Stalls, Market Roars

The Market keeps rallying while the Economy is stalling as the virus is spiking. There continues to be a major disconnect between Wall Street and Main Street. The Market keeps looking past the problems, to a much more prosperous period in the Spring and Summer of 2021. Getting there still looks very challenging. California announced a new stay-at-home order yesterday. Fiscal stimulus optimism has been the big theme in the press though still a lot of details need to be hashed out, including around longstanding contentious issues such as state and local government funding and liability protections. The Labor Department reported 245,000 new jobs for November, and the unemployment rate edged down to 6.7%. The rate is down by 8 percentage points from its recent high in April but is 3.2 percentage points higher than it was in February.

California announced new stay-at-home rules that take effect Saturday. The state has been split into 5 regions: The Bay Area, Greater Sacramento, Northern California, San Joaquin Valley and Southern California. In the event that the remaining ICU capacity in a region falls below 15%, it will trigger a 3-week stay-at-home order. On Thursday, Governor Newsom said that 4 regions, all but the San Francisco Bay Area, could meet that threshold “within a day or two.” Bay Area health officials sprung into action already, deciding not to wait for the 15% threshold, and declared a stay-at-home order to begin Monday. The joint statement said “in light of the rapidly escalating surge in hospitalizations statewide, it’s believed more aggressive action is necessary in the Bay Area to slow the surge and prevent local hospitals from being overwhelmed.” Virus cases in the Bay Area have reportedly quadrupled in a month. The restrictions will remain in effect for the rest of the year.

California is the most populous state in the nation, with 30 Million people. Producing $3 Trillion in economic output, the Golden State is the engine of America. As a standalone, it would be the 5th largest economy in the world, ahead of the United Kingdom. This new shelter-in-place is a really big deal. We all know it. This is going to be a Holiday Season like no other. The traditional spending at stores, bars, restaurants and travel are going to come quite short this year. Small businesses continue to struggle. Service and travel related industries have gotten crushed by the pandemic. The Economy is not tired. It’s injured.

Discussions in Washington indicate there is finally the potential for a near-term deal on a new coronavirus relief package. There was a $908 Billion proposal rolled out earlier this week from a bipartisan group of Senators. It’s no done deal. Senate Majority Leader Mitch McConnell said things are moving in the right direction and compromise is within reach. But he has neither expressed support for the bipartisan plan nor backed away from his own more limited proposal. He seems to be locked-in on the runoff in Georgia in January. Besides, the bipartisan plan at this point is really broad and vague. The Democrats and Republicans still have to resolve two longstanding sources of contention: additional funding for state and local governments and coronavirus liability protections for businesses. They better get moving, and fast. Is it any wonder that 80% of Americans disapproved of the job Congress was doing heading to the election?

There are many contrarian indicators in place suggesting the Stock Market is overheated. The Market seems to be sniffing out signs of inflation ahead with higher interest rates. Though still near historic lows, the 10-Year Treasury yield is back at the highs of the year, bumping up against 1%. It fell below 0.4% during the crash in the Spring. It has been trading sideways since, now at the highs of the range. The 10-Year Treasury was at 2% to start the year.

I’m about to geek out on you with Market metrics, because there’s some really interesting and important stuff going on beneath the surface. Bank of America/Merrill Lynch tracks money flowing into various asset classes. They’ve done it for years. Their latest Flow report indicated that Global Equities experienced an inflow of $9.7 Billion this week. That’s a really big number. Global Equities attracted a record $115 Billion in the month of November. Vaccine optimism and getting past the election has provided a major tailwind for stocks. There has been serious rotation of leadership out of Large Cap Tech and into the Value and Cyclical sectors, like Financials, Industrials and Energy. There hasn’t been a major exodus from Growth and Momentum as many of those stocks continue to do well too. The rally has simply broadened out. 93% of the S&P 500 stocks are now trading above their 200-day moving averages. That is the highest in 7 years. The Tech-heavy Nasdaq is trading at 2 standard deviations above its 50-day moving average. Professor Schiller’s CAPE valuation (Cyclically Adjusted P/E) is back above the 1929 peak. There has been a mad dash for stocks, and a fear of missing out seems to be back in play with the expectation of a traditional Santa Rally to close out the year.

Money keeps leaving the Bond Market too. Treasury/Government Bond Funds saw their 4th straight week of outflows. The only area in the Bond asset class attracting money is in Junk Bonds. Junk Bond (also known as High Yield, for better Wall Street marketing purposes) spreads are also at their tightest since February, just before the Spring Market crash. When Junk Bond spreads tighten closer to Treasuries, it generally means money is aggressively flowing into them and investors are getting less compensation for the additional risk they’re taking. Junk spreads exploded higher during the crash as investors sought safety. This too is a contrarian indicator of investors chasing gains and signs of topping.

Precious Metals funds saw $2.4 Billion in outflows in the latest week. That was the 8th largest on record. Gold funds lost a record $9 Billion over the past 3 weeks. That’s a buy signal to us. It tells us that the selling in Gold is nearly complete after digesting the massive gains over the Spring and Summer. The Put/Call ratio’s 5-day moving average fell to its lowest level in 20 years. That’s a sign of great complacency. It’s also an indication of increased speculation. Call buying is very speculative. And there’s been a lot of it. Puts are like insurance in the Market. It’s usually very cheap when there is little fear out there. Prices surge amidst a crisis. When things are going well, who likes paying insurance premiums? You pay for it if and when you need it. You see, the cost of insurance spikes when the house is already on fire… or something like that.

We don’t see another massive sell-off ahead, like there was in the Spring. But we wouldn’t be surprised for another healthy shakeout, to correct these excesses built-up since the election. A sell-off would be very buyable. We’re ready for whatever comes our way.

Have a nice weekend. We’ll be back, dark and early on Monday.


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