Slight Wednesday Decline
Compared to all the recent wild swings, Wednesday’s trading session was boring. S&P 500 fell 0.36% which was a 0.88% reversal from the high. To me, it seems like the market is uncertain about its next move. It has had such momentum, but since everyone is positioned bullishly, it’s tough to make new highs. That June 8th high will likely stand for at least a few weeks if not a few months.
On the other hand, this recent uncertain action hasn’t led to a massive reversal where the momentum goes south. Some would be buyers on that decline. Currently, many are negative on stocks in the intermediate term because there are so many potential headwinds.
Biggest one is the spike in COVID-19 cases in the biggest few states. Florida, Texas, and California have the biggest economies in the nation. 2nd biggest risk is a corporate tax increase. Adding in high valuations, makes this a bad area to be extremely long with an intermediate time horizon.
Trash Is In Style
Investor sentiment hasn’t gotten worse even though the market has stalled out in the past week. If anything, the euphoria is even higher. CLOU cloud ETF hit another record high on Wednesday as it was up 0.73%. It’s up 62.88% since its March bottom. Sea Limited stock was up 5.96% and is up 181% since March 20th. There is extreme speculation in this name. Personally, I wouldn’t buy it.
That being said, we must congratulate individual investors in this group because these are life changing gains. That’s almost a triple in a few months. Many have been wrongly bearish on cloud stocks for a few weeks. On the other hand, when this bubble ends, these stocks will likely fall below where we went negative. If they fall enough, we can look to buy stocks such as Adobe and Autodesk.
Cloud stocks that lose money are great compared top the trash stocks retail traders have been buying in the past month. They have been buying bankrupt companies and stocks with no revenues such as Nikola. Russell 1,000 micro cap index is 10% from its record high even though the average company has a debt to enterprise ratio of 65% which is above the S&P 500’s which is 30%.
The chart below shows a hypothetical garbage portfolio which is an equal weighted portfolio of companies with a credit default swap over 1,000 basis points as of April 1st. The garbage has outperformed the MSCI US index dramatically even with Thursday’s decline.
When you add up the garbage performance with the spike in retail trading and the high hedge fund positioning, it looks like the market is ready to fall. It's strange to see why some blue chips that aren’t in tech need to fall significantly. We see garbage and momentum stocks falling in the next few weeks. Since tech is such a big part of the index, it can fall 10%to 15% from the recent top.
Review Of Thursday’s Action
The market had a worse day than indicated by the S&P 500 as the Russell 2000 fell 1.77%. It’s 7.18% off its recent high. On the other hand, the Nasdaq was up 0.15%. Fact that this index is up 10.45% year to date and 26.33% year over year seems painfully wrong. If the economy is about to mostly go back to normal like equities indicate, then these tech stocks should fall. It’s basic logic.
Worst stocks on the day were cruise lines as Norwegian fell 8.4%. 3 up sectors were consumer discretionary, communication services, and tech. This is because of the FAANG names as Amazon was up 0.98%, Netflix was up 2.67% (very close to a record), Apple was down 14 basis points, Facebook fell 5 basis points, and Alphabet rose 0.42% despite regulatory threats. Alphabet’s biggest risk factor is regulatory.
The worst sectors were energy and the financials which fell 3.28% and 1.37%. Some are very bullish on the regional banks. KBW regional bank index fell 3.07%. Triumph bank, which has locations in Texas, fell 6.19%. It is only up 19.77% from its March bottom.
Banks are faced with higher defaults and lower net interest margins. It’s a terrible time to be a bank. Fed might not raise rates for 2-3 years. That’s mostly priced in by now. Rumors of rate hikes in a year or two will cause these stocks to rally.
COVID-19 Is Terrible In A Few States
COVID-19 just keeps getting worse in some of the biggest states in the country. Arizona and Oregon have had the biggest spikes. New York, New Jersey, and Illinois are seeing the biggest declines in new cases. Florida, Texas, and California are in trouble. The chart below shows the recent spike in cases in Texas. It doesn’t include the data from June 16th and 17th in which there were 4,413 new cases and 3,511 new cases.
From June 14th to June 17th, the 7 day average of daily new cases has increased from 1,926 to 2,533. I don’t think it will slow unless tougher restrictions occur. I’m going to make a prediction. If the 7 day average of new cases per day exceeds 5,000 in the next few weeks, we will see a sharp correction in stocks. Houston is the hardest hit area in Texas.
Conclusion
The stock market had a very boring Wednesday. Under the surface, some negative forces are working that will push stocks lower. We still have high retail speculation, very long fund managers, higher COVID-19 cases in Texas, high valuations, garbage stocks doing well, and fears of a tax hike next year.
If the number of cases in Texas continues to spike, we will see stocks drop. Just because the stock market has ignored it so far, doesn’t mean it’s not important. Haven’t we already learned that lesson this year as stocks ignored the COVID-19 crisis in China in January and February, before crashing in March?