The cautious flow is carrying professional investors and Wall Street strategists, who see already-lush returns this year and are bracing for a less-generous phase with an increasingly selective tape and more than a cursory pullback in stock indexes before too long.
The (subjectively) insane, shooting-the-rapids action includes hype-driven auctions for non-fungible tokens (digital claims on content built on a blockchain), the ongoing bid for so-called meme stocks in the options market, the hunt for exotic yield-bearing instruments, and some opportunistic startups rushing to go public while curious capital is flowing fast.
One notable feature of these opposing attitudes and behaviors is that they have coexisted peacefully for some time. So far, participants in each game have been able to ignore the other.
The core financial markets are operating rationally, if hopefully without a lot of high-adrenaline speculative energy or New Age futurism. Not yet, at any rate.
If, as the old adage goes, politics is the art of the possible, then market handicapping is the art of the plausible. Everyone understands that markets are inherently unpredictable with any degree of consistency, so market strategy is about synthesizing precedents and probabilities to form a plausible outlook.
Possible scenario
Right now, after a 20% gain in the S&P 500 over the last eight months and no more than a 5% drop since last October, the plausible case is for more turbulence and muted gains. That is implicit in the current consensus year-end S&P 500 price target, which is significantly lower than Friday’s closing level of 4535.
This weekend’s Barron’s strategist outlook roundup neatly captures the collective mood: “Tailwinds remain in place, but headwinds are on the horizon, which could slow stock gains. Stimulus spending has peaked, and economic and corporate earnings growth are expected to slow until the end of the year. Furthermore, the Federal Reserve has almost certainly promised to begin tapering its bond purchases in the coming months, and the Biden administration has proposed raising corporate and personal tax rates. None of this is likely to sit well with shareholders of increasingly expensive stocks.
“In other words, brace yourself for a volatile fall, with competing forces buffeting stocks, bonds, and investors.”
The fact that many people hold this opinion does not make it correct. As a baseline for setting expectations, this is most likely the correct outlook. However, it suggests that the most surprising path for the rest of the year would be a continuation of the low-drama climb, possibly accelerating into a less-orderly rally, with no discernible index-level correction.
The notion that it is time for some retaliation because everything is too high also ignores the fact that the most economically sensitive parts of the market peaked between three and seven months ago and have all experienced significant corrections (banks, transports, homebuilders, small-caps, even semiconductors).
Constant rotations and the massive ballast of stable mega-cap growth stocks that draw buyers as macroeconomic concerns mount have saved the S&P 500 from further declines. The process has allowed overstressed sectors to reset and correct, while also preventing the overall market from overheating.
For three months, some technically savvy investors have been wary of low market breadth readings, but as they’ve improved recently, the summer appears to have administered an internal, targeted correction while sparing the large-cap benchmarks.
The self-healing homeostatic rhythm of the market
It cannot and will not continue in this manner indefinitely. September could be a minefield of Fed reorientation, legislative wrangling, and consumer malaise. However, many tactical investors have been frustrated by over-anticipating bearish catalysts to change the market’s tone.
The market has pushed all FAANMG stocks to yields of 4 to 2.5 percent free cash flow, or 25 to 40 times year-ahead free cash flow forecasts. Is that the right number, given that investment-grade debt yields around 2%? It’s difficult to say, but it’s not insane.
The core story of the 2021 market is beneficial sector rotations against a backdrop of low bond yields and generous credit markets (and the similar low-volatility post-election-year advances of 2013 and 2017). And they tell us when we should start worrying more.
If the rotations begin to deteriorate – if banks and FAANMG sell off together for more than a day, for example – it could signal a shift in the market’s self-healing homeostatic rhythms. And, if credit markets soften significantly, raising the cost of capital for riskier borrowers, it would indicate a shift in market character that should not be dismissed.
The market’s resilience is due in large part to extraordinary policy responses to the Covid lockdowns, which poured trillions into consumer and business accounts, driving nominal GDP growth to previously unheard-of levels among this generation of investors.
This effectively eliminated the “left tail” of highly negative economic outcomes and propelled the economy well above “stall speed.” It also helps to explain why the Delta Covid surge has resulted in a defensive shift in market leadership rather than an outright exit.
More specifically, we are now in an era of corporate abundance and cash generation, which means that large-company CEOs have fewer difficult decisions to make. It is possible to invest for growth in a supply-constrained economy, pursue acquisitions, and share cash flows with investors.
According to Jurrien Timmer, global macro strategist at Fidelity Investments, the S&P 500′s combined dividend and share-buyback yield – now around 3% – was roughly the same at a similar point in the long-running bull markets of the 1950s-’60s and 1980s-’90s. The yield fell to 2.5 percent during the generational advance that ended in 1968, and it peaked at 1.7 percent in 2000.
It is worth noting that strategies targeting companies with high cash-return yields, such as the Cambria Shareholder Yield ETF (SYLD) and the WisdomTree U.S. Quality Shareholder Yield Fund (QSY), have outperformed the market this year.
The outlandish parts
But what about the “crazy” parts?
The NFT fever is a lot of hot money denominated in cryptocurrency rushing toward digital “art,” or squibs of code entitling a buyer to some vaporous ownership of images, consuming far more than its fair share of investor oxygen.
It’s difficult to call it an asset class. And if you don’t call it that – and instead call it hobbyist collecting or status-signaling consumption or a proof-of-concept for smart contracts or some meta game – it no longer qualifies as a pocket of excess relevant to financial markets.
Are investors straying into marginal, unrated corporate debt in search of a little extra yield in their portfolios? Yes, it appears. So we’ve arrived at that point in the risk cycle. However, many eyes are on it, and we have previously stated that credit spreads should be displayed on all screens as a threat-detection tool.
And, yes, some of the most buzzed-about youth-courting consumer brands of the 2010s (Allbirds, Sweetgreen, Warby Parker) are lining up to go public after years of holding out, just as their Generation Y core customer is approaching 40.
However, it is reassuring that the market is not overly enthusiastic about ostensibly Zeitgeist-riding new issues these days. Honest Co.’s share price has been cut in half since its first-day high. Since going public through a SPAC merger, Sofi has lost a third of its value. When Coinbase and Robinhood went public, they were met with a barrage of criticism.
And, in general, the Renaissance IPO ETF and SPAC indexes peaked in the first quarter and have since lagged behind the mainstream equity market.
Just another sign that the market can remain rational for a longer period of time than those who call it crazy can maintain credibility.
e-commerce stocks to avoid
“In this environment, a platform like eBay should do reasonably well,” Sebastian said in an interview with “Squawk on the Street.” “Because they have millions of sellers, they can diversify where they source product for their marketplace.”
eBay shares fell 1.5 percent to around $75.30 per share. The losses come on the heels of a down day for the S&P 500 and Dow Jones Industrial Average, as investors are concerned about the impact of the Covid-19 delta variant on the economy.
However, eBay’s stock is still up roughly 49 percent year to date. FactSet reports that 16 of the 28 Wall Street analysts who cover eBay have a hold rating on the stock. Eight analysts believe the stock is a buy, three believe it is overweight, and one believes it is underweight.
According to Baird’s Sebastian, PayPal is another way to play the e-commerce trade without directly purchasing shares of a retailer dealing with inventory shortages. PayPal accounts can be used by online shoppers to pay for their purchases from a variety of retailers.
“In this environment, we also like PayPal. They provide funding for payments. Transaction values should be higher this year, with less discounting than in previous years, according to Sebastian.
According to FactSet, roughly 85 percent of the 47 analysts covering PayPal rate the stock as a buy or overweight, while nearly 13 percent rate it as a hold. According to FactSet, only one analyst rates PayPal as a sell.
PayPal’s stock rose about 0.5 percent to just under $291 per share on Tuesday. The stock is up about 24% year to date, but it is still more than 6% below its all-time intraday high of $310.16 on July 26.
Sebastian had an outperform rating on PayPal and eBay as of Friday.
Sebastian also stated that, as the holiday shopping season approaches, he feels better about Amazon than some of its competitors.
“They have a significant amount of their own ocean freight capacity reserved. They do have a marketplace where they can source inventory from a variety of third-party merchants, so we are less concerned about Amazon than we are about other retailers or companies that rely on traditional shipping providers or manufacturers for product.”