The common explanation for the Nasdaq
On Wednesday the Fed said inflation actually may well NOT be transitory and moved up the path for interest-rate hikes. On Thursday growth stocks surged and the Nasdaq jumped back to a new record. Huh?
It only makes sense if the narrative the past month was wrong, or Thursday’s action was a head-fake.
I’m in the latter camp and believe the pivot by the Fed will ultimately be negative That’s probably not surprising if you’ve followed my coverage this year: on April 16 I warned of the dominoes I saw lined up for a bear market. On April 29 I said it may not be a buy-puts market yet, but it likely is a sell-calls market. We didn’t get any closing highs in the Nasdaq after my article, until this week.
The bear case I laid out was basically two-fold. Firstly, the influx of new liquidity in financial markets is peaking as the Fed looks to begin unwinding its support, and as fiscal stimulus shifts from freebie checks to tax-supported infrastructure policy. In my mind that means peak speculation and peak valuations. Second, that the Nasdaq’s correlation with the bond market made it exposed to more downside in the event of another liftoff in yields.
Obviously we didn’t get the liftoff in yields. We got the opposite, and the Nasdaq rallied — so at least the correlation is still very much there, which means yield spikes are still a risk if they happen. A lot of the negative forces I’ve highlighted this year have indeed come to fruition — bond selling at the start of the year, peaking tech valuations, a crypto blowup, and now a hawkish Fed — but the Nasdaq has rallied through it all. It’s like Rocky going the distance with Apollo. I don’t think it’s invincible though.
The first step of a liquidity-driven rollover will be the drawdown in speculative excess. Despite some pockets of craziness in meme stocks like AMC, the peak speculation argument looks strong. Out-of-the-money call buying in the options market has slowed way down, tech valuations are clearly downtrending, the Nasdaq’s are doing the same at a slightly slower pace.
And of course, the most clear gauge of sentiment and risk-taking appetite, the crypto market, is in total disarray. Dogecoin is trying to usurp bitcoin’s seat at the throne, the scalding-hot speculation in DeFi is slowing, and King Bitcoin is struggling to extricate itself from the $30,000 level. Bitcoin’s weakness symbolizes the waning consumer appetite for trading since peak stimulus earlier this year.
The U.S. stock market is shaking off this slow rollover in froth because earnings attached to the economy are ramping up and there are enough stocks outside growth companies to offset the valuation decline that’s happening. But even as it makes new highs, the stock market is slowing down.
You can see this by dividing the COVID period into three sections defined by fluctuations in the relationship between growth and value stocks: 1) from the S&P 500 low in March 2020 to September 1, when growth stocks’ performance relative to value peaked 2) value’s period of leadership, from Sep. 2020 to March 8, 2021, and 3) growth’s resurgence from March 8 to now.
From March 2020 to the growth apex, the S&P 500 added an average 0.5% a day. During the value dominance from September to March this year, it averaged 0.06% a day. In the latest growth resurgence, it’s added 0.16% a day. The market needs growth companies to be in front to reward the amount of speculative investing that made stocks top-heavy at the start of the year. Yes, growth has had an impressive comeback this past quarter but it’s done so under the assumption that inflation will be transitory, and we just learned from the Fed that may well be wishful thinking.
You might also notice the relative strength of growth next to value is approaching the downtrend line from September, suggesting we are probably nearing the end of this outperformance. A market where growth underperforms is likely the beginning of the end of our decade-plus bull market in the Nasdaq.
Finally, the index itself despite making highs still looks dubious. Each record this year has been a harder slog, and momentum measured by RSI is downtrending since September. The last time I spotted such a pattern was when bitcoin had a false breakout to 65k. And thus I will continue my cautious coverage until growth stocks break the trend of underperformance or the rate of change of the Nasdaq increases.