Technically, the Dow and S&P snapped their 7-day winning streak.
Technically.
I hardly consider a decline of 0.03% and 0.11% for the Dow and S&P, respectively, a down day.
Meanwhile, the Nasdaq and Russell saw a record close for who knows how many consecutive days.
Can the market keep this up? Who even knows anymore. Everything seems to defy expectations and logic. Yeah, it's possible. But I'd be surprised if we don't see at least one sharp pullback before the end of the week.
The sentiment is surely rosy right now. The economic recovery appears to be gaining steam, and the Q1 decline everyone predicted might not be as swift as we anticipated- if at all. President Biden's stimulus could officially pass within days as well and provide much-needed relief to struggling businesses and families.
Have you seen the vaccine numbers lately, too? More people in the U.S. have now been vaccinated than total cases. On Monday (Feb. 8), vaccine doses outnumbered new cases 10-1. New daily COVID cases have also reached their lowest levels since October.
With Johnson and Johnson's (JNJ) one dose vaccine candidate seemingly days away from FDA approval, the outlook is certainly more positive at this point than many anticipated.
But we're not out of the woods yet, and three non-pandemic related factors still concern me- complacency, overvaluation, and inflation.
Jim Cramer's "Seven Deadly Sins" from Mad Money Monday night (Feb. 8) reflect many of my concerns too:
Source: CNBC
Yes, I know I keep saying to beware. I also know that earnings are on pace to rise by over 20% in 2021. Since 1980, only 12 years have earnings increased by 15% or more. Except for 2018, the market gained an average of 12% in all of those years.
But consider some valuation metrics that scream “bubble.”
As of February 4, 2021, the Buffett Indicator, or the ratio of the total US stock market valuation to the GDP, was at a level not seen since the dotcom bubble. If you take the US stock market cap of $48.7 trillion and the estimated GDP of $21.7 trillion, we're nearly 224% overvalued and 84% above the historical average.
Keep in mind; this chart was dated February 4. This number has only grown since then. Tuesday (Feb. 9) was hardly a down day. If anything, it was plain dull.
Fears of a bubble are genuine. The S&P 500’s forward 12-month P/E ratio is back to above 22 and well above the 10-year average of 15.8. The Russell 2000 is also back at a historic high above its 200-day moving average. Tech stock valuations are again approaching dot-com bust levels.
Bank of America also believes that a market correction could be on the horizon due to signs of overheating.
While I don’t foresee a crash like we saw last March, I still maintain that some correction before the end of Q1 could happen.
Corrections are healthy and normal market behavior, and we are long overdue for one. They are also way more common than most realize. Only twice in the last 38 years have we had years WITHOUT a correction (1995 and 2017).
A correction could also be an excellent buying opportunity for what could be a great second half of the year.
Bank of America also echoed this statement and said that “We expect a buyable 5-10% Q1 correction as the big ‘unknowns’ coincide with exuberant positioning, record equity supply, and ‘as good as it gets’ earnings revisions.”
The key word here- buyable.
My goal for these updates is to educate you, give you ideas, and help you manage money like I did when I was pressing the buy and sell buttons for $600+ million in assets. I left that career to pursue one where I could help people who needed help, instead of the ultra-high net worth.
With that said, to sum it up:
While there is long-term optimism, there are short-term concerns. A short-term correction between now and the end of Q1 2021 is possible. I don't think that a decline above ~20%, leading to a bear market will happen.
Hopefully, you find my insights enlightening. I welcome your thoughts and questions and wish you the best of luck.
Tech is Quite Frothy
Figure 1- Nasdaq Composite Index $COMP
Please don’t call me a Debbie Downer for this. I just follow the trends and the numbers.
I remain bullish on tech and the earnings that continue to defy expectations and crush estimates. I'm also incredibly bullish on subsectors such as cloud computing, e-commerce, and fintech for 2021.
But please monitor the RSI.
The Nasdaq closed at a record high for the fourth consecutive day, hasn’t had a down day since January, and is trading above 14000 for the first time in its history.
But please monitor the RSI.
Did I say that twice?
Since December, let's break down the Nasdaq and how it has reacted whenever the RSI has exceeded 70.
December 9- exceeded an RSI of 70 and briefly pulled back.
January 4- exceeded a 70 RSI just before the new year and declined 1.47%.
January 11- declined by 1.45% after exceeding a 70 RSI.
Week of January 25- exceeded an RSI of over 73 before the week and declined 4.13% for the week.
Every single time the RSI exceeded 70, I switched my Nasdaq call to a SELL.
Why?
The Nasdaq is trading in a precise pattern.
The RSI is back above 70, and as much as I don't want to, I feel like I have no choice but to call this a SELL. I'm bullish but a bit concerned. Tech valuations, especially the tech IPO market, terrify me. SPACs don't help either. SPACs were one of Jim Cramer's "Seven Deadly Sins," too.
The ratio of market value to total revenues has also not been this high since the dotcom bust.
I still like tech and am bullish for 2021. But for now, I'm going to stay conservative, follow the RSI pattern, and say SELL and take profits.
For an ETF that attempts to directly correlate with the performance of the NASDAQ, the Invesco QQQ ETF (QQQ) is a good option.
The S&P “Snapped” Its Winning Streak
Figure 2- S&P 500 Large Cap Index $SPX
The S&P kind of, sort of, had a down day on Tuesday (Feb. 9). This is the first time the S&P declined in 7 trading sessions. But 0.11% in the red is hardly a decline?
This is a streaky index that seemingly rips off multiple-day winning streaks or losing streaks on a weekly basis. Now and then, though, it can show inconsistency, make you scratch your head, and go on a frustrating losing streak.
Three weeks ago, the S&P was hovering around a record-high. Its forward P/E ratio was the highest since the dotcom bust, and the RSI consistently approached overbought levels.
Two weeks ago, it was nearly oversold.
Last week, its RSI ticked back above 62, ended the week with consecutive days of record closes, and saw a 5-day winning streak.
We’re also at a forward 12-month P/E ratio of over 22 and well above the 10-year average of 15.8.
What could be on tap for this week? Who even knows anymore. But if earnings keep on outperforming, and the sentiment remains stable, it could be another strong week.
Consider this though. The S&P has traded up and down weeks for roughly the last 4 weeks.
I said before that once the S&P approaches a 3600-level, we can start talking about it as a BUY. Despite last week’s rally, short-term concerns remain, with medium and long-term optimism.
To me, because of the RSI and how the index has traded, it remains a HOLD.
A short-term correction could inevitably occur by the end of Q1 2021, but for now, I am sticking with the S&P as a HOLD.
For an ETF that attempts to directly correlate with the performance of the S&P, the SPDR S&P ETF (SPY) is a good option.
The Dow Has Momentum on Its Side
Figure 3- Dow Jones Industrial Average $INDU
The Dow still has momentum on its side, despite Tuesday technically being a “cool off” day. If anything, the index closed more flat than down.
What makes the Dow more attractive than the other indices, is it’s comparatively undervalued.
After its downturn two weeks ago, the Dow was by far the index closest to oversold and in BUY territory. It saw a decline in 6 of 7 days and briefly saw its RSI plummet to a sub-40 level.
Since last week though, it has seen considerably more momentum, returned to positive territory for the year, and recovered all of its losses, and hit a fresh record close.
If you want to start initiating positions, go ahead. It’s at a solid entry point, especially considering that many analysts call for it to end the year at 35,000.
From my end, though, I still have some short-term questions and concerns and feel like the Dow could see another pullback.
My call on the Dow stays a HOLD, but this could change soon.
For an ETF that looks to directly correlate with the Dow's performance, the SPDR Dow Jones ETF (DIA) is a strong option.
Beware of Inflation
“The rich world has come to take low inflation for granted. Perhaps it shouldn’t.” -The Economist.
Outside of complacency and an overvalued market, my biggest concern has to be inflation.
Last Thursday (Feb. 4), the President of the Federal Reserve Bank of Kansas City, Esther George, told Bloomberg News that the Fed was still “far away” from achieving its goals, and that it was too soon to discuss scaling back its unprecedented massive bond-buying program.
Pay very close attention to the possible return of inflation by mid-Q2 or Q3.
George’s statement confirms that the Fed will allow the GDP to heat up and possibly overshoot in the medium-term. An aggressive stimulus could take effect this week too.
We will see what happens to GDP growth by the end of Q1 2021, but I no longer think it will sputter as much as I previously thought.
If at all.
Jobless claims continue to fall and beat estimates, and the most recent Department of Labor Report indicated that we could very well be on the road to recovery.
I’m not opposed to hiking the minimum wage either, but when you keep printing money, hold interest rates this low, and let the GDP heat up unchecked, inflation will inevitably return.
This stimulus plan is needed. But could it overheat the GDP? Very possibly.
The steepening of the yield curve reflects this too and is the steepest it’s been in years. Long-term Treasury yields have risen faster than shorter-term yields, and could be a sign that Wall Street is betting on a speedier economic recovery compounded by inflation.
The 10-year breakeven rate reflects inflation risk as well.
If you are looking to the future to hedge against inflation, look into TIPS, commodities, gold, and potentially some REITs.
In the mid-term, I have BUY calls on the SPDR TIPS ETF (SPIP), the Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF (PDBC), and the iShares Cohen & Steers REIT ETF (ICF).
Mid-Term/Long-Term
Taiwan, South Korea, and More for Best Emerging Market Exposure
Figure 4- SPY, EWT, ERUS, THD, VNM, EWY, EIDO, ECH, EPU comparison chart- Sep. 1, 2020-Present
Since September, the SPDR S&P 500 ETF (SPY) has gained around 11.60%. When you compare that to my top emerging market picks for 2021, it has underperformed.
When you look at the CAPE ratio of U.S. markets compared to the rest of the world, this also seems like an awfully low bang for your buck.
The CAPE ratio takes real earnings per share (EPS) over ten years and smooths out fluctuations in corporate profits that can always occur throughout different business cycles. It’s also known as the Shiller P/E ratio.
Consider this too.
A surge in commodity prices due to a weakening dollar combined with shifting demographics could send emerging markets upwards in the long-term too.
PWC also believes that emerging markets (E7) could grow around twice as fast as advanced economies (G7) on average in the coming decades.
For 2021, the following are my BUYs for emerging markets and why:
iShares MSCI Taiwan ETF (EWT)- Developing country, with stable fundamentals, diverse and modern hi-tech economy, regional upside without China’s same geopolitical risks.
iShares MSCI Thailand ETF (THD)- Bloomberg’s top emerging market pick for 2021 thanks to abundant reserves and a high potential for portfolio inflows. Undervalued compared to other ETFs.
iShares MSCI Russia Capped ETF (ERUS)- Bloomberg’s second choice for the top emerging market in 2021 thanks to robust external accounts, a robust fiscal profile, and an undervalued currency. Red-hot commodity market (a big deal for a declining dollar), growing hi-tech and software market, increasing personal incomes. Compared to many other developed and emerging markets, Russia could have more than a 35% upside for its equities in the long-term as well.
VanEck Vectors Vietnam ETF Vietnam (VNM)-Turned itself into an economy with a stable credit rating, strong exports, and modest public debt relative to growth rates. PWC believes Vietnam could also be the fastest-growing economy globally. It could be a Top 20 economy by 2050.
iShares MSCI South Korea ETF (EWY)- South Korea has a booming economy, robust exports, and stable yet high growth potential. The ETF has been the top-performing emerging market ETF since March 23.
iShares MSCI Indonesia ETF (EIDO)- Largest economy in Southeast Asia with young demographics. The fourth most populous country in the world. It could be less risky than other emerging markets while simultaneously growing fast. It could also be a Top 5 economy by 2050.
iShares MSCI Chile ETF (ECH)- One of South America’s largest and most prosperous economies. An abundance of natural resources and minerals. World’s largest exporter of copper. Could boom thanks to electric vehicles and batteries because of lithium demand. It is the world’s largest lithium exporter and could have 25% of the world’s reserves.
iShares MSCI Peru ETF (EPU)- A smaller developing economy but has robust gold and copper reserves and rich mineral resources.
Month-to-date, Russia has been the top performer gaining over 6.3% while South Korea has been the laggard and barely gained 0.70%.
Much of Russia’s surge this month can be due to a surge in oil and commodity prices.
South Korea’s slowdown was inevitable after the massive rally it’s seen. I mean what do you expect when you see a return of nearly 139% since March 23? The Russell, which has supposedly overheated, has underperformed this by over 7% in the same period!
Outside of the aforementioned country-specific ETFs, you can also BUY the iShares MSCI Emerging Index Fund (EEM) for broad exposure to Emerging Markets.
Long-Term
I remain convinced that the economic recovery is going better than expected as the progress in administering the vaccines improves. I do still have some concerns about complacency, overvaluation, and inflation.
We may be at the beginning of the end of the pandemic, and despite what could be a bumpy ride, 2021 should be a big year for stocks.
Small-caps, value stocks and cyclical stocks could significantly surge. I just will have a much better feeling for them in the second half of the year. I think we are overdue for another down week or two before entering a powerful buying opportunity for the second half of the year.
Summary
I am becoming increasingly optimistic for the second half of 2021.
However, until COVID-19 is brought under control, a battle between optimism and pessimism is inevitable.
But it’s getting better.
The crash and subsequent record-setting recovery we saw in 2020 is a generational occurrence. I can’t see it happening again in 2021. But as I said in the intro, I think a correction is inevitable due to complacency and overvaluation.
If there is a short-term downturn, though, take a breath, stay cool, and use it as a time to find buying opportunities. Do not get caught up in fear and most of all:
NEVER TRADE WITH EMOTIONS.
If you cautiously bought a little bit two weeks ago, you’re probably very happy right now. Even though the downturn to close out January wasn’t a full-blown correction, it was indeed an excellent opportunity to rebalance and add exposure.
That’s why I love down weeks—especially overdue ones.
Consider this too. Since markets bottomed on March 23rd, ETFs tracking the indices have seen returns like this: Russell 2000 (IWM) up 131.87%. Nasdaq (QQQ) up 96.63%. S&P 500 (SPY) up 77.27%. Dow Jones (DIA) up 70.95%.
In the long-term, markets always move higher and focus on the future rather than the present.
To sum up all our calls, I have SELL calls for:
- The iShares Russell 2000 ETF (IWM), and
- the Invesco QQQ ETF (QQQ)
To sum up all our calls, I have HOLD calls for:
- The SPDR S&P ETF (SPY), and
- the SPDR Dow Jones ETF (DIA)
I am more bullish for these ETFs for the second half of 2021 and the long-term.
I also recommend selling or hedging the US Dollar and gaining exposure into emerging markets for the mid-term and long-term.
I have BUY calls on:
- The iShares MSCI Emerging Index Fund (EEM),
- the iShares MSCI Taiwan ETF (EWT),
- the iShares MSCI Thailand ETF (THD),
- the iShares MSCI Russia ETF (ERUS),
- the VanEck Vectors Vietnam ETF Vietnam (VNM),
- the iShares MSCI South Korea ETF (EWY),
- the iShares MSCI Indonesia ETF (EIDO),
- the iShares MSCI Chile ETF (ECH),
- and the iShares MSCI Peru ETF (EPU)
Additionally, because I foresee inflation returning as early as mid to late 2021…
I also have BUY calls on:
- The SPDR TIPS ETF (SPIP),
- the Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF (PDBC), and
- the iShares Cohen & Steers REIT ETF (ICF)
Thank you.
Matthew Levy, CFA
Stock Trading Strategist
