Call It

Call It

There’s lots to look at in coming weeks. Right now, it seems to me there are a lot of people who just want to declare victory on a position. Sunday futures opened up, so the bottom must be in. Or, Israeli conflict is causing a rush for safety, and downside potential is huge.

Why rush to choose? I do admit, I understand, but respectfully disagree with the stance of bulls. It’s true that since the Covid lows, every time we get this much stress in the system, we bounce. It seems reasonable to believe that will happen again.

My problem with that is it seems too aggressive. Bond yields got nuked, the war drums are getting louder, and the big tech indexes are increasingly seven large tech stocks. Have we reached a natural limit on how far this move can go?

Realistically, as of last week, the Magnificent 7 large tech stocks have grown to just shy of 30% of the S&P 500. Their outperformance vs. the average stock is about 80%.

Outside of those seven stocks, the market reaction (the average S&P 500 stock is -1% YTD) seems reasonably rational. With higher-for-longer rates, valuations should come down. There are a variety of ways to think about that, whether it be as the discount rate in a valuation model or the competition for investment dollars between stocks and bonds. As bond yields grow, they become better competition. In their quarterly call, Blackrock mentioned that pension plans and similar entities are actively looking at shifting to bonds. Realistically, if you have a plan to pay out 4% a year and you can get a guaranteed 5% a year, why wouldn’t you?

If nothing else, it seems fair to say bonds offer a better value to equities than they did a few months ago. Even that seems like an insufficient description to what’s going on. Another way to look at it is that you can decompose yields into inflation and real yields. The real side of yields really took off as this year has gone on but is now starting to turn around. What that broadly means is people started to get excited about economic prospects but have lately started to reconsider.

That doesn’t have to continue but is certainly worth watching. If real yields are in the process of topping, TIPS are a very logical place to be. You get paid for some decent real yield assumptions plus whatever inflation gives you, going forward. For equities, the stocks that performed well in the first half of last year seem like logical choices.

That said, we still haven’t seen obvious signs that a recession is nigh. If bears are right that we are in danger of a significant decline, that decline still seems buyable.

In short, while many seem eager to declare bulls or bears the winner right now, I’d say uncertainty is high. I’d rather wait and see if bulls are correct this is just another buyable decline. I freely admit that I’m unlikely to get the lowest price available by waiting, but I think the risks are too high. Oversold conditions are where bad crashes happen, and there’s too much that can go wrong, right now, with Middle Easy trouble, upcoming earnings, and broad volatility on the rise. I think it’s inappropriate to declare winners, right now.