Since we are constantly getting new readers, we like to start our weekend piece with a quick note every once in a while...and the first piece of the year would seem to be a good time to do this once again.
Our “Weekly Top 10” piece is not meant to be a review of the week’s 10 most important developments. Instead, we try to focus on what most people are not focusing on...and when we do talk about the mainstream issues, we like to look at them from a unique angle. We also talk about issues from both sides of the bull/bear ledger...and thus sometimes our bullet points conflict with one another. However, we’re just trying to give both sides of the story...and we always try to let you know which side of that ledger we stand on any given issue.......Finally, we provide the commentary in three different “versions”...so that you can spend as much time...or as little time...on each one of them as you would like........Thank you have we hope you all have a very happy, healthy, safe and prosperous New Year!
THE WEEKLY TOP 10
Table of Contents:
1) After the initial big bounce last spring, the rally has been all about liquidity.
2) The Fed will be committing suicide if they keep the spigots wide open once the pandemic subsides.
3) The biggest surprise in the first half of 2021 will be a contra-trend bounce in the dollar.
4) After an upcoming “breather,” commodities should see another strong run in 2021.
4a) Silver and gold should end 2021 at a much higher level.
5) “Golden crosses” in the energy stock ETF’s.
6) Long-term rates look poised to move higher...and that does matter on several levels.
7) Seeing a few (small) cracks in the chart of the housing stock ETF.
8) We still think rotating WITHIN the tech sector is a good idea.
9) Will Biden be like LBJ?.....Taiwan is the globe’s #1 geopolitical issue.
10) Don’t listen to anybody who says the new high in margin debt is nothing to worry about!!!
11) Whatever you do, don’t buy Tesla or Bitcoin on margin!
12) Summary of our current stance.
1) The stock market is priced for perfection, so although it could rally a bit further in early 2017, the odds are very low that it will rally in a meaningful way next year. Even if we reach the best levels of economic & earnings growth that are being predicted by Wall Street right, it will not be enough to justify today’s levels on a fundamental basis.....In other words, this market is all about liquidity...and it will be vital to understand this as we move into 2021.
2) Of course, there is still one way the market could keep on rallying. If the Fed & other central banks keep the liquidity spigots wide open after the pandemic subsides, the markets could move much higher. However, that will create a bubble in the stock market...which, once popped, will clobber the corporate bond market. So we believe the Fed will want to avoid that...because the real risk in the global economy (due to the insanely large levels of corporate debt in the world) is still deflation.
3) The fundamental picture for the dollar over the longer-term is decidedly bearish. However, sometimes sentiment and positioning cause a serious contra-trend move in any asset class...when those issues reach extremes. The have reached huge extremes in the dollar...and thus we believe that one of the biggest surprises in the first half of next year will be a strong/sharp (multi-week & maybe even multi-month) bounce in the dollar. Therefore, investors need to have a plan in place for this likely move in the currency market.
4) Over the next year or two, we think that any inflation in asset prices will begin to shift away from equities and towards commodities. However, given our call for a multi-week bounce in the dollar, we should see a pull-back in commodities that goes with it. That said, if the CRB commodity index can eventually move above its current level (either now or after a pull-back), it’s going to confirm a change in the long-term trend for this asset class.
4a) As we mentioned in our “Morning Comment” last Thursday, both silver and gold are testing key resistance levels...and thus any further rally will be bullish for these precious metals on a technical basis. Due to our belief that we’ll see a pull-back at some point before long, we don’t want to jump the gun, but 2021 should be another good year for the precious metals.
-5) We think the energy stocks will continue to do well in 2021. They should take a “breather” if/when the dollar bounces and commodities pull-back, but this under-owned and over-hated group still has plenty move upside potential in our opinion. Not only are these stocks trading at levels that they saw when WTI oil was trading in the low $30s, but the XLE and XOP have recently experienced “golden crosses.” They haven’t seen those kind of bullish “crosses” since late 2017, but the last two times they took place, both ETF’s saw very nice (further) rallies.
6) Interest rates....The yield on the 10yr note has broken above several key resistance levels...and it has done this after forming a very nice “base” over the summer. The chart on the yield curve (as measured by the 2yr/10yr spread) has seen a similar move. Both are bumping up against another resistance level. If they break those levels, it will confirm a change in the their two-year tends...which, in turn, should have an impact on several other investment vehicles going forward......Yes, it’s great that yield are still VERY low on an historical basis, but it’s not as great as it used to be.
7) The rise in long-term rates has led to a nice rally in the bank stocks, so if rates breakout even further, it should help that group even more. However, the flattening out of the rally in the housing stocks has also corresponded with a rise in long-term rates. This is not problem yet...and there are many reasons to remain bullish on the housing sector. However, there are some levels we’ll be watching closely on the charts...that, if broken, will lead us to turn much less constructive on this group.
8) Tech is far from dead, but investors are going to need to be more selective in 2021. The FAANG names are still great companies, but they’re still over-owned and overvalued (though most of them are a bit less so than they were in late August). We are worried about several of those FAANG names due to regulatory issues under the new Administration, so we think investors should rotate WITHIN the tech sector towards AI, cloud and chip related stocks.
9) On the political side of things, we’d note that President-Elect Biden will be the first President since LBJ who has an intimate knowledge of how to get things done with Congress...and has the relationships to help get some things done. You might not like what he gets done, but at least he might be able to break the grid-lock.......On the geopolitical front, we still believe that Taiwan will be the most important geopolitical issue of this decade. We do not think the U.S. & others will sit idly by (like they did with Hong Kong) if/when things come to a head with Taiwan.
10) Leverage is a lousy timing tool, BUT it’s still VERY dangerous!!!!......Arguments about whether we’re in a bubble or not don’t matter...because the stock market does not have to reach bubble proportions to fall into a deep correction of 15%-20%. In fact, it does not have to move into bubble territory before it can fall into a bear market either!.....Also, those who say that record leverage is a lousy timing tool are correct, BUT don’t take solace in this argument. When record leverage is reached, the eventual unwinding of that leverage is always VERY painful for the stock market.
11) We believe that Tesla and Bitcoin are in bubbles. Yes, they might move higher over the very-near-term...and we definitely think that Bitcoin will move a lot higher over the very-long-term. However, at some point over the next few months we believe that it is likely that these two asset will see declines of 30% or more. Therefore, it will be very dangerous to own them using margin going forward. If you own them on margin, instead of using the decline as a great opportunity to buy it on weakness, you’ll be forced to sell it at exactly the wrong time (when it’s just staring to bottom)!!! You cannot “ride out” a large decline in a stock or any other asset if you own it on margin....your broker won’t let you!
12) Summary of our current stance.....Although we have been very bullish on the stock market for most of the last quarter, e believe the stock market has moved far ahead of the economy...and anything the economy will likely become over the next 12-18 months. Therefore the stock market will likely see a deep correction of 15%-20% next year (probably starting in the first half). If the pandemic subsides, so will some of the central bank liquidity. If the pandemic becomes worse, the liquidity will only soften an inevitable decline, but it won’t prevent it.......Hopefully, 2021 will be NOTHING like 2020...but we DO think it will be very similar in one regard. It should be a year when nimble and active traders who take advantage of moves in both directions will profit much more than those investors who use the old the buy and hold strategy that has worked so well for a long time.
1) Even though the next few weeks will be tough for the pandemic, this healthcare crisis will definitely subside before long...and the new strains of the coronavirus will not become a big problem because the vaccines will indeed work very well against them. Also, the 2021 economy is going to grow a lot more than the consensus is thinking right now...and earnings are going to beat the consensus expectations for next year by a wide margin as well.
If you have been reading our work recently, you know that the above statement is not what we believe...BUT it IS what the stock market is pricing-in right now. Thus, it is pricing-in perfection..........This does not mean that it cannot rally a bit further in early 2021, but the problem is that despite what the old saying on Wall Street says, the stock market is NOT “always right”...it’s only “always right” EVENTUALLY.
Right now, the stock market does not reflect what is going on in the economy or what is going on with earnings. More importantly, the market is not currently reflecting the kind of growth we’ll get next year either. (This is especially true for earnings. Earnings almost never reach their consensus early-year estimates by the end of the year. They are almost always shaved considerably as we move through the year.....Yes, the S&P 500 companies ALWAYS beat their broad earnings estimates every quarter...but that’s only after those estimates have been cut significantly in the months before the quarterly earnings are reported.) Therefore, given its extremely high valuation levels of 22.5x forward earnings and a record price to sales ratio of 2.8x, we think it will be very difficult for the stock market to rally in a significant way next year.
Another way of highlighting what we’re trying to say is to point out that even if the the most bullish estimates for next year come to fruition, it will only take us back to growth levels that existed before the pandemic. Many pundits try to say that this would be great, but those pre-pandemic growth levels (both economic and earnings growth) were not fabulous at all...so we seriously question how they will justify a material rally in stocks next year!
GDP growth was 2.33% in 2019...which was lower than the 3.18% rate we saw in 2018....and earnings growth for the S&P 500 was FLAT in 2019!!! Despite those mediocre (at best) growth rates, the stock market rallied 30% that year! Therefore, the stock market was overbought and expensive just before it topped out in February due to the coronavirus...and since the stock market is more than 10% higher than it was just before the pandemic clobbered the markets, it’s even more expensive today.
So what we’re saying is that if we do indeed get the kind of growth that takes us back to pre-pandemic levels next year! This leads us to ask, so what??? That will merely take the market back to an overbought and overvalued level...instead of very overbought and extremely expensive (like it is today). That is not the kind of set-up that provides for further substantial gains in the stock market.
Let’s face it, even if earnings explode to the upside...and the S&P 500 earns $200 (which would give it an unlikely YOY gain of more than 40%)...a rally to 4000 on the S&P would still leave it an expensive multiple of 20x. In other words, a move to 4,000...even one that is led by a 40%+ rise in YOY earnings growth...would give the S&P a rally of only 6%-7%...and still leave it at an expensive level. So think about what kind of earnings growth it will take to push the S&P 500 to a FAIRLY valued level...even if the index stayed at or below 4,000! It would take an earnings increase of more than 60% vs. 2020 to move the S&P to a fairly valued level if it does not rally at all next year!
Don’t get us wrong, a 6%-7% gain in the stock market (to 4,000 on the S&P) would still quite good on an historical basis. But the point is that we’re going to have to see a HUGE increase in the fundamental growth to justify the CURRENT level of the stock market...not to mention what it will take to give the stock market a gain in the mid-single-digits! Thus a double digit gain in the stock market will be very, very hard to achieve...and if we do get it, it will take us into bubble territory. That might be good for investors over the short-term, but it will be a disaster for them on a longer-term basis.......In other words, this market is all about liquidity...and it will be vital to understand this as we move into 2021.
2) Of course, as we alluded to in the last sentence of point #1, there IS one thing that COULD take the stock market much higher. If the global central banks keep the liquidity spigots wide open...even after the pandemic subsides and the vaccines help bring the global economy back to its previous levels...the stock market could become even more over-valued. In other words, if they keep the pedal to the metal in terms of liquidity, the stock market could continue to push further above a level that would be justified of the fundamentals. Instead of the fundamentals catching up to a flat or declining stock market, the stock market will continue to move further above those fundamentals.
The problem with that scenario is that it will cause more bubbles...and certainly move us into one in the stock market. We believe that the Fed does not want to create a situation where a wide spread and massive bubble develops. If that happens, when the bubble eventually (and inevitably) bursts, it will be one that they will not be able to control.
This time last year, the only thing anybody could talk about was the bubble in corporate debt. Well guess what, that bubble has grown in a major way in the last year. U.S. corporate debt is up to more than $10.5 trillion...which is almost half of the country’s GDP. As we mentioned recently, $3.6 trillion of that debt is just one notch above junk. If another Fed-induced bubble is formed in the stock market, it’s eventually bursting will freeze-up the debt market in a way that would make this past spring and 2008 look like a picnic.
In other words, the Fed will have to pull-in their horns at some point if/when this most recent wave of the pandemic subsides. If they don’t nobody is going to be worried about inflation down the road, it will be deflation that will make a BIG come-back...and the Fed will have few tools to fight it this time around.
3) Let’s move away from the stock market and talk about some other asset classes. We’ll begin with the dollar. Although we expect the dollar to end 2021 lower than it is right now, we believe that the biggest surprise in the markets in the first quarter of next year will be a “tradeable” (multi-week) bounce at some point in the first quarter of next year. (We think it will likely begin in the first half of the 1st quarter.) This will have an important impact on other asset classes...but we talk about those issues in later bullet points...and stick with the greenback in this bullet point.
The reason we believe that the dollar has become quite ripe for a bounce that will last several weeks (maybe even a couple of months) has nothing to do with its underlying fundamental picture. The twin deficits should theoretically keep the dollar falling. HOWEVER, sometimes it is essential to look beyond the fundamentals...when other factors reach extreme levels.
We’re seeing several of these outside factors coming into play all at once right now. The first one is the sentiment behind the dollar. You can’t go a day without reading or hearing a bearish comment about the greenback in the financial press. We’d also note that bullish reading in the DSI data is pushing 90%. So you can see that sentiment is about as bearish as it gets on the U.S. dollar.
The same is true for the issue of “positioning.” The recent BofA fund manager survey highlighted that the “short dollar” trade was the second most crowded trade around the globe. On top of this, the COT data shows that the dumb money “speculators” (or “specs” as we call them on Wall Street) have their largest net short position since 2011...and the smart money “commercials” have their largest net-long position since financial crisis!!!....Finally, the weekly RSI chart on the DXY dollar index is very close to its most oversold level of that past decade.
In other words, way too many people are on one side of the boat in the dollar trade...and thus there is nobody left to sell the greenback. No, this does not mean that the dollar will bounce strongly on Monday of next week, but it does mean that it has become VERY ripe for a relatively strong bounce soon. These readings are so extreme that they also tell us that any bounce should last for a lot more than just a few days.
Again, it could take several more weeks before the bounce takes place, but we STRONGLY believe that investors who have leveraged positions that could/should be impacted by a contra-trend bounce in the dollar will need to be very careful over the first few months of 2021. We also STRONGLY believe that this kind of bounce can easily take place even though the longer-term fundamental picture is decidedly bearish for the dollar.
4) Commodities......We have been saying for many months that we believe that the 8-9 year bear market in commodities has come to an end...and that a new bull market is emerging. The more than 60% rally in the CRB Commodity index since the March lows seems to be bearing us out. Having said this, the CRB is now testing its trend-line going all the way back to its 2011 highs...so it will need to see some more upside follow-through before it breaks above that line in a significant fashion and confirms the change in the long-term trend for this asset class. (Remember, as we just stated above, the Fed wants to avoid deflation at all costs...and in a weird twist of fate, keeping deflation at bay could/should entail keeping the stock market from inflating too far over the next year or two. Therefore, inflation should shift at least some-what away from the equity market...and towards the commodity markets.)
Given what we just said about the dollar, there is a decent chance that we won’t get this confirmation in the very-near-future. If the dollar sees a multi-week (and relatively sharp) bounce, it’s almost certainly going to cause a pull-back in the CRB. This will not be a problem at all with our long-term call on commodities. After the outsized rally it has seen over the past nine months, a pull-back would actually be normal and healthy (just like it will be normal for the dollar to bounce strongly at some point in the first quarter after such a big decline this year).
Since the dollar’s upcoming bounce might not come for a couple of weeks, we do not want to send up any kind of short-term warning flag on the commodity asset class just yet. However, we’re becoming more neutral on them over the near-term...and will be watching the currency market closely for signs that we should at least send up a yellow warning flag.
What we’re saying is that we expect an pull-back in commodities at some point in the first quarter, so we do not want to remain aggressively bullish up at these levels. Instead, we’ll be looking for a pull-back in the asset class before we get aggressively bullish in this area once again. However, just because we believe the group could/should see a pull-back, it does not change our longer-term bullish stance. So there is little question that we will get much more bullish on commodities once again at some point as we move through 2021. (We’ll talk more specifically about crude oil and the energy stocks in point #5.)
On the charts, we’ll be watching the CRB commodity very closely in the coming weeks and months. After an expected pull-back in the commodity asset class, we’ll be watching to see if the CRB can move its trend-line from 2014, it will make a test of the early 2020 highs of 188 quite likely. If it can then break above that level, the trend-line going all the way back to 2011 will come into focus. That level is more than 30% higher that today’s level...which would have some very interesting implications for several stock groups as well.
4a) Before we move onto WTI crude oil and the energy stocks, we want to reieterate what we said about two other commodities in one of our “Morning Comments” last week...silver and gold.
Let’s start with chart on silver. This precious metal made a nice “double-bottom” at about $22.75 in late November...and it has followed that up with a nice “higher-high” above its early November highs. That said, silver did fall below its trend-line from March last month, but it is now testing that line once again. Therefore, if it can regain that trend-line...and move above that line in a meaningful way...the combination of a “double-bottom,” a “higher-high,” and a move back above the trend-line should be very bullish for silver on a technical basis. In other words, this is a long winded way of saying that any further rally in silver as we move into the new year will be bullish for the commodity.
As for gold, the yellow metal has been in a downward sloping trend-channel since early August. It is now testing the top line of that channel, so a meaningful break above $1,900 would signal a breakout of that channel. If it can then rally further and move meaningfully above its November highs of $1,950...it would follow the breakout of its current “channel” with a nice “higher-high”...and thus confirm a change in the intermediate-term trend for gold to the upside.
Of course, since we’re looking for a near-term bounce in the dollar of significance, we definitely HAVE to wait for a more meaningful breakout in both of these precious metals before we can raise a major green flag up the flag pole. However, once we move further into the new year, these precious metals should follow-up last year’s good year with another strong one. (The move in Bitcoin has taken the thunder from the record years that these two precious metals had in 2020.)
5) Needless to say, if we think that commodities in general could be vulnerable to a short-term correction at some point in the first quarter, that would include WTI crude oil as well. If the black gold sees a pull-back, so should the energy stocks. However, given that the XLE energy stock ETF rallied strongly over the past two months and still stands 43% above its late October lows (and more than 64% above its March lows)...a pull-back at some point in the first quarter of the new year would actually be normal and healthy. (We’d also note that the XOP oil and gas E&P ETF stands 48% above its late October lows and a whopping 94% above its March lows!)
Therefore, we remain bullish on the energy sector over the longer-term, but we would not be aggressive at current levels...even though many of these energy names have pulled-back a little bit already. Having said this, we believe that a pull-back from their overbought levels in crude oil and other commodities (due to our expectations for a bounce in the dollar) will provide a great opportunity to buy the best run and best capitalized energy stocks in the market place. Once these overbought conditions are worked-off, we will turn much more aggressive on the energy stocks once again.
There are a lot of non-believers in terms of this rally in crude oil and the energy equities, but we think it can re-establish itself once the recent extremes are worked-off. (If the Fed was smart, they’d be more interested in buoying the oil market than the stock market. As we have seen over the past five years, it has been a decline in the high yield market that has had the biggest impact on creating important problems in the credit markets...in 2016, 2018/19 and last March. Yes, the sharp decline in the stock market can obviously had an impact on the credit markets, but in recent years, it wasn’t until the high yield market fell apart that the Fed needed to step to the plate and provide liquidity. They weren’t protecting the stock market, they were merely doing what the needed to do to keep the credit markets open and running. Yes, a deep bear market in stocks is something that could cause the credit markets to freeze up once again, but given how much exposure the high yield market has to the energy sector, a decline back into the $20’s for crude oil is something that would almost guarantee a major problem in the fixed income markets.
Anyway, looking at the energy stocks, since they’ve already seen a mild pull-back recently, they might not get hit as hard by decline in crude oil prices as they have in the past. We’d also note that the XLE has experienced its first “golden cross” since late 2017! That “cross” was followed by a further rally of 18% in the XLE over the several months. (The golden cross before that one...in 2016...was followed by a further rally of 22%!) Of course, we’d like to see the “golden cross” become a more meaningful one before we get too excited...and that might not come until we take a “breather” in the group. However, we believe this under-owned and under-loved group has a lot of upside potential for the full year in 2021.
We’ll finish this point by highlighting that the XOP made a “golden cross” two weeks ago...and the rallies that followed those kind of bullish “crosses” in 2017 and 2016 were 20% and over 40% respectively..........(Remember, a “golden cross” is when an asset’s 50 day moving average crosses above its 200 DMA when they both moving averages are rising. A “death cross” is the exact opposite.)
6) Interest rates.......We’ve talked a lot about the technical condition of the yield on the U.S. 10yr note...and the U.S. yield curve (2yr-10yr spread). They are both at a very important technical juncture, so we’ll review their charts first...and then we’ll talk about what it means for the markets next year.
First of all, the chart shows that the yield on the 10yr note has set up quite nicely in 2020 for an important change in trend. That does not mean it will skyrocket next year...and we certainly don’t think it will. However, if it breaks above the 1.0% level, it’s likely going to signal a move up to at least 1.5% and maybe even higher in 2021......The yield formed a very strong “base” over the summer...which included a nice “double-bottom” at 0.5%. It has since moved higher and broken above its 200 DMA...its June highs...AND its trend-line from late 2018! It has been bumping up against 1% for almost two months now, so if it can break above that big round number, it’s going to follow the breakout above all of these resistance levels we just mentioned...with yet another key “higher-high.” That will be a strong signal that the two year trend for lower long-term interest rates has been reversed. (Yes, yes...the tend of lower interest rates is several decades old. We’re merely talking about a change in the most recent...2-year trend...that saw long-term rates drop in such a severe manner. So it’s still a change in trend...even if the very-long-term trend remains in tact.)
As for the U.S. 2yr/10yr spread, it broke above its trend-line from early 2018 a long time ago...and it has made a series of “higher-lows” and “higher-highs” since September of last year! In fact, the yield curve has steepened so much that it has moved to a level that is higher than it was in early 2018!!! Now, this “higher-high” above the early 2018 highs is only a slight one, but if it can see any more upside movement (more steepening), it will also confirm a change in the multi-year trend for the yield curve.
As we will touch-on in the next point, this should have an important impact on several equity groups in 2021 (assuming the 10yr yield and the 2yr/10yr spread both do indeed see a breakout in these charts). However, we also want to note two important issues. First of all, we readily admit that both would still be a ULTRA low levels on an historical basis even if they breakout, so we don’t want to say that 10yr Treasury notes will suddenly provide some serious competition for stocks. However, they will still lower what should be considered fair value for the S&P 500...and thus 22.5x forward earnings will be more expensive than it would be if long-term rates remained at 0.5%......No, that might be anywhere near enough to cause problems for the stock market any time soon, but it will make an already expensive stock market even more expensive.
7) Since we took so much time talking about the bank stocks last week, we’ll focus on another interest rate sensitive group this week: the housing stocks. However, we’ll start by give a very quick update on the chart of the KBE bank ETF...to add what we said two weeks ago about the banks. The KBE is now bumping up against its 200 week moving average. That moving average provided some very strong support throughout much of 2019. Once if finally broke below that line last winter, it fell out of bed. That “old support” level is now the “new resistance” level. Therefore, if (repeat, IF) it can break back above its 200 week MA in any significant way, it should lead to another leg of the rally in this key group. (First chart below.)
However, on the flip side of things, we do have to worry a little bit about the housing stocks. We have been very bullish on this group most of the past two years. (We’d did warn about short-term pull-backs on several occasions, but stayed bullish for most of the past two years.) To be honest, we’re still bullish on the sector from a fundamental factor...especially given the low level of supply in many parts of the country.
However, we do need to point out that the rally off of the March lows has stalled-out considerably over the past four or five months. Looking at the ITB home construction ETF, it has been in a sideways range between $52 and $60 since August. It is right in the middle of that range right now, so we are NOT sending up a yellow warning flag on the group (much less a red one). So we don’t want to sound like we’re on the cusp of turning bearish on the housing stocks. We are, however, watching it very closely...because the “flattening-out” the ITB has corresponded with the rise in the 10yr yield off of its 0.5% double-bottom low.
One would think that we’ll have to see a much bigger rise in yields to have in create the kind of higher mortgage rates that would stymie the housing market in a significant way, but if (repeat, IF) the ITB breaks below the bottom-end of its sideways range at any time over the coming weeks and months, we will definitely have to raise turn much less constructive on the group. We’d also note that the 50 DMA on the ITB has turned negative...which it hasn’t done since February of last year...so we will definitely keep one eye on this group going forward. (Second chart below.)
8) Tech is far from dead, but investors are going to need to be more selective in 2021........As we have said many, many times, the FAANG companies are good/great companies...but that had become too overvalued and too over-owned at the end of the summer. Needless to say, after their underperformance since September, they are not as over-owned as they used to be, but the big players still have very large positions...and the stocks are still expensive. Most of the names have not exceeded their early September highs, so they have indeed been lagging for quite some time now. Even the ones that have made new highs (GOOGL & AAPL) don’t look great on the charts. GOOGL has flattened out since early November (while the broad market has continued to rally) and AAPL is at risk of making a “double-top” (like it did in 2015...just before it began a 30% decline).
However, the biggest concern we have has to do with regulation. Putting at least some restrictions on the Facebooks, Amazons & Google’s of the world is a bi-partisan issue. Considerable regulation is not something that has to pass Congress, so the new administration can show that they are “doing something” to protect the voters of America more quickly through this path.....This goes back to what we’ve said about the “Presidential Election Cycle” in recent months. Part of the reason the market has a tough time in the first year of a new administration...is because they’re willing to make use their post-election momentum to do some difficult things that might not be all that great for the economy over the short-term. They’re willing to do this because it needs to be done...and they want to do it far enough in front of the next Presidential election so that any negative impact the move has inflicted has worn-off by then. (Don’t listen to those who say the Biden Administration wants to set things up so that they win the mid-term elections. No administration gives a rat’s ass about the mid-term election...and THAT’S why they always lose seats in those mid-terms. The only one to gain seats since 1934 was George W. Bush in 2002...and that’s because people felt he did a good job after 9/11. It had nothing to do with his economic policies.)
With all of this in mind, we believe investors should continue to look at other areas within the tech sector when it comes to their tech exposure. Cloud computing and AI are still in their early innings of their advances. The semiconductor industry still looks very bright. We do admit that many of the chip stocks have been taking a breather over the past 2-3 weeks, but this is not a concern right now. The group had become very overbought by early December and it needed to work-off some of that condition. If/when the broad market sees a correction, this group will certainly see some weakness as well. However, we believe that these three areas within the tech sector will have a good year in 2021. Thus investors should continue to accumulate shares of those names...especially if we get a correction in the broad stock market.
9) Okay, let’s talk politics. On the bullish side of things, Joe Biden brings something to the White House that has not been seen since the 1960s. We now have somebody who has worked in Congress for many, many years...and knows the players and knows how things get done. That is what Lyndon Johnson did in the 1960s...when he became President and passed the Civil Right Act, the Voting Rights Act, and several pieces of legislation that decreased the poverty rates in the U.S. Of course, Vietnam ruined his presidency...but things he DID get things done when he was President.........You might not like what President-Elect Biden GETS done, but a least we have a chance to get rid of some of the grid-lock that exists in DC today (even if the GOP holds the Senate).
On the negative side of things, we still believe the relationship between the U.S. and China will be one of the most important (if not THE most important) geopolitical issues of this decade.
Throughout the entire election year of 2020, the pressure that the U.S. will put on China on the trade issue will still be strong. We spent a lot of time last year highlighting how the candidates from both sides of the political aisle (and the business aisle) supported a tougher stance against China...and thus this issue would not change in a significant manner after the election...no matter who won. From everything we have heard from President-Elect Biden and his transition team, they will indeed keep the pressure on China going forward.
Of course, there are reasons to think that the rhetoric from the Biden Administration will be much less contentious...and that they'll try to use a strategy that is much less unilateral in its implementation (one that includes our allies much more extensively). Therefore, (at least the public) relationship between the two countries is likely to be less toxic.
That said, as we said above, not only do we have political and business leaders from all sides of the spectrum have been critical of China's trading practices and they want to keep the political pressure on them...but we also have to note that China has not been living up to its side of the "First Phase" of the trade agreement. They only bought about 25% of what they agreed to buy in the first half of the year...and they have not improved on that rate much in the second half (when the pandemic was much less of a problem for the Chinese). Therefore, even if the trade issue with China might not be as toxic as it was under the Trump Administration, it's not going to go away either.
More importantly, the much bigger issue in the U.S./China relationship is Taiwan. China is fresh off the successful (and complete) takeover of Hong Kong...without ANY real push-back from ANY other global power (including the U.S.). Will this give China the confidence to lead them to move quickly on Taiwan in 2021? (To be honest, it would be seem to be smart to us if China waited several years to move on Taiwan, but we also know that testing a new President in his first year in office is something our advisories have done many time in the past.)
We'd also note that the China had not shown any signs of “waiting” when it comes to the Taiwan issue. They continue breach the Taiwan Straights median line as we've moved into the end of they year. It's something they have reportedly done dozens of times over the past three months. This, Taiwan says, shows that Beijing no longer recognizes Taipei’s claim to the waters...which is not good for those who are looking for a stabile situation in that part of the world......On top of this, unlike Hong Kong, Taiwan is showing a very strong willingness to fight China to keep their independence. That might sound absurd, but that’s what the Germans thought about the UK back in the 1930s.
Taiwan's President, Tsai Ing-wen, has once again reached out to China recently...saying she is ready and willing to engage in talks...as long as China is will to put aside confrontation. China has not responded to Tsai's olive branch...and they cut off a formal talks mechanism when she was elected President in 2016. In fact, they have repeatedly rejected Tsai's advances...saying she first has to accept Taiwan is a part of China, something she has not been willing to do.
In fact, China still seems to be ratcheting up the pressure on Taiwan. Although they did not respond to President Tsai directly, one Chinese official did say that they would stand by the "one China" principle...and "only by eliminating the scourge of 'Taiwan independence' can there be peace and stability in the straight."
Some people think that the U.S. and others will not stand-up to China if/when they make a move on Taiwan. They believe everyone will just sit on their hands...just like they did with Hong Kong.......Now that Intel (INTC) has stopped producing chips, Taiwan is the focal point for chip production for the world. Therefore, if it falls into China’s hands, it will put the U.S. and Europe at a tremendous disadvantage. We do not think it is too much to say that access to the major producer of chips in the world right now is very comparable to Japan’s need to access to oil in the 1940s. The only (big) difference is that the U.S. wants chips for (mostly) peaceful reasons and Japan wanted the oil to expand their empire.
With Intel deciding to outsource much of their manufacturing capabilities, Taiwan (via Taiwan semiconductor) will become THE key supplier of semiconductors in the world.....Yes, the U.S. did sit on its ass while China took full control of Hong Kong, but given how important the supply of semiconductors has become to the global economy, we do not think that the U.S. will NOT sit idly by if/WHEN China makes it move on Taiwan.
Therefore, the issue of Taiwan...and what it will mean for U.S./China relations...IS something investors should DEFINITELY be thinking about when they map out their longer-term investment strategies...for 2021 and beyond.
10) Leverage is a lousy timing tool, BUT it’s still VERY dangerous!!!!.........One of the things that seems to be making the rounds again at the beginning of this year...just like it did at this time last year...is whether the stock market is in a bubble or not. We strongly believe that this argument is a waste of time...because the stock market does not have to reach bubble proportions to fall into a deep correction of 15%-20%. In fact, it does not have to move into bubble territory before it can fall into a bear market either! Yes, the bear markets of 2000-2003 and 2007-2009 were indeed preceded by bubbles. However, there were many, many bear markets between WWII and 2000 (and dozens and dozens of deep corrections over that time frame)...and NONE of them was preceded by a bubble.
In other words, one of the worst arguments anybody can make is to say that we don’t have to worry about the stock market right now because we’re not in a bubble. (Of course, some people believe that we are already in a bubble, but that does not matter whether we’re in one or not. Yes, if a bear market begins after a bubble has formed, the bursting of that bubble will create a deeper bear market than one that does not follow a bubble...as the massive levels of leverage need to be unwound. However history tells us that deep corrections and bear markets CAN develop long before a bubble is formed in any market.)
We believe that the market is much closer to bubble territory than most people realize. The indicators that we are at or near bubble levels are many fold, but there is only one that really makes a market dangerous...extreme levels of leverage. We can talk about all of the froth that we’ve seen in the market place all we want...and there are plenty of examples to talk about. Whether it is extreme valuations, very high bullish sentiment, very low put/call ratios, record low levels of mutual fund cash, crazy trading on the first day of IPO’s, the money going into SPACs, the action in Bitcoin, TSLA, etc., etc., etc....there are plenty of examples of froth in the market place. However, leverage is the most dangerous one.
This is why the news that margin debt has moved to a new all-time high should be very worrisome to all investors. Don’t get us wrong, we DO agree that high levels of margin debt is a LOUSY timing tool. A high level of margin debt does not become a problem until the stock market begins to decline in a meaningful way. (That’s why crashes rarely happen from a top. They tend to come later...because it’s only when the market has fallen by a decent amount that “margin calls” (and thus “forced selling”) comes into play. However, just because the market usually does not fall after we see new record highs in margin debt...does not mean that it cannot fall quickly.
IN OTHER WORDS, EXTREME LEVELS OF MARGIN DEBT ARE NEVER A REASON OR A CATALYST FOR A STOCK MARKET DECLINE. IT’S ALWAYS SOMETHING ELSE THAT KNOCKS THE MARKET DOWN. HOWEVER, MARGIN DEBT DOES EXACERBATE A DECLINE ONCE IT BECOMES A MEANINGFUL ONE! Thus, if any of the new strains of the coronavirus...or problems with the vaccines...or a renewed blow-up between the U.S. and China...or anything else...causes the stock market to decline in a material way any time soon, the issue of margin debt WILL become a BIG problem for the stock market VERY quickly.
Therefore, just because a new record level of margin debt is usually not followed by an immediate and substantial decline in the stock market...it does not mean that market is unlikely to drop in that kind of serious fashion soon. It only means that it won’t fall in a compelling way soon IF nothing else knocks the market down over the next few weeks and months......If something else DOES become the catalyst for a meaningful decline at any time in the near future, the unwinding of the record levels of leverage (margin debt) in the stock market WILL make the drop a powerful one.
11) The Tesla and Bitcoin bubbles..........We believe that Tesla and Bitcoin are both in bubbles...but what does the term “bubble” really mean? We like the definition that says, “A bubble is created by a surge in an asset’s price that is driven by exuberant behavior and takes the price of that asset to a level that well above its intrinsic value.”
We have used the example of AMZN frequently. It was in a bubble in 1999 and its stock price got crushed over the next few years. The stock was trading at an insane valuation in 1999. Of course, people could have argued that AMZN was not trading well above its intrinsic value for 2014 back then, but they would have just been guessing. Therefore, even though AMZN went on to change the world...and eventually justify its stock level of 1999, it was WAY to early to do it that year.....In other words, no matter how much any company or asset will eventually change the world...and no matter how profitable it will eventually become...even the best stocks and assets get so far ahead of themselves that they reach bubble territory and fall back to earth in a significant way. All of this can (and does) take place EVEN if the price goes A LOT higher over the very-long-term.
What were trying to say is that we believe that Bitcoin will likely go a lot higher over the long-term...and that Tesla could go a lot higher over the longer-term as well. So if you think that the only thing defines a bubble is something that goes down...and stays down for a very long time...than these two assets are not in bubble. However, no matter how you define their positions right now, we believe that they will both face sharp declines of more than 30% in 2021 (just like they have in almost every year over the past decade). We also believe that a 50% decline in each of these assets is possible. (So we think a 30% drop is probable...and a 50% drop is possible.)
Needless to say, a lot of people disagree with us, but we definitely want to make a very strong point here. It is INCREDIBLY risky to buy either of these two assets...ESPECIALLY Bitcoin...on margin up at these levels. Given how many times that have both decline more than 20% over the past 10 years, those who buy it on margin could be making a big mistake.
In other words, if you love Bitcoin and think it could go to $50,000 or more in the years ahead (like we do), but it drops 30% next year, you’re going to get a margin call! Therefore, instead of using the decline as a great opportunity to buy it on weakness, you’ll be forced to sell it at exactly the wrong time (when it’s just staring to bottom)!!! You cannot “ride out” a large decline in a stock or any other asset if you own it on margin. Your broker won’t let you. You will get a margin call, so at the very least you will need to make sure you have enough cash on hand to meet that margin call if you want to hold onto that asset for the long-term during a substantial decline.
Ok, enough preaching, but before we talk about just how overbought Bitcoin has become, we’d also say that it imperative for any investor to keep solid stop-out levels on any long positions in Bitcoin and Tesla. That is the best way to protect your gains...and avoid losses!!!!!!!
As for the chart on Bitcoin, its weekly RSI chart has moved above 93 this weekend. That makes it more overbought than it was in late 2017...and thus makes it a very risky play above $30,000. It’s not quite as overbought as it was in 2013, but it’s getting quite close. We do admit that the monthly RSI is also below its highs from both 2017 and 2013...so maybe it will go to $50,000 immediately (and before it falls 30%). We’re just saying that it has reached a level where investors have to be incredibly careful.
12) Summary of our current stance.......In the last bullet point of the week each week, we tend to review what we’ve seen in all of the previous points of our report that weekend. This weekend, we’re going to be a bit more brief and to the point...but it will still give you a good idea of how we’re feeling about the markets right now.
Basically, although we have been very bullish on the stock market for most of the last quarter, we believe that it has moved far beyond anything that represents what is going on in the U.S. economy right now...or anything that is likely to be reached in the next 6-12-18 months. Therefore the risk/reward equation has moved significantly towards the risk side of the ledger. Yes, the stock market CAN still go higher over the next few weeks. In fact, we’ve been saying for a while now that the year-end rally should last into the early weeks of 2021. However, our reasoning has absolutely nothing to do with the underlying fundamentals. Global central bank liquidity is the only reason that the stock market has reached these levels. That liquidity could take it higher over the near-term.
However, one of two things is very likely to happen this year. Either the pandemic is going to subside...which will lead the global central banks to provide less liquidity to the markets (in order to avoid the kind of bubble we can never recover from)...or the pandemic will get much worse because the vaccines won’t work against the new strains. That will cause another full-scale lockdown of the economy...and all the liquidity in the world will not be able to keep the stock market from falling in that scenario. (It could/should soften the decline, but it won’t be able to prevent a significant one from taking place.)
Either way, even though the line of least resistance is still higher as we move into the new year...a serious correction of 15% or more is all but assured for some point in 2021 in our opinion...and we believe that it is likely to begin at some point in the first quarter. (It’s funny how the perma-bulls always say that a big decline of 15%-20% is not in the cards before it happens...but then they say it should have been obvious to everyone AFTER it happens. They then say that 15%-20% decline are normal and healthy...even though they never warn you about anything more than the possibility of a 5% pull-back.)
The kind of correction we’re talking about is one that nimble traders can take advantage of and make some nice profits. Longer-term investors can ride them out...AS LONG AS THEY ARE NOT LEVERAGED. Those who are leveraged will not be able to take advantage of the normal & healthy corrections we see almost every year. Instead of “buying on weakness,” they’ll be engaged in “forced selling” (through margin calls, etc.). Therefore, instead of buying of taking advantage of a great buying opportunity, they’ll be forced to sell at exactly the wrong time.
Hopefully, 2021 will be NOTHING like 2020...but we DO think it will be very similar in one regard. It should be a year when nimble and active traders who take advantage of moves in both directions will profit much more than those investors who use the old the buy and hold strategy that has worked so well for a long time.
Matthew J. Maley
Chief Market Strategist
Miller Tabak + Co., LLC
Founder, The Maley Report
275 Grove St. Suite 2-400
Newton, MA 02466
Although the information contained in this report (not including disclosures contained herein) has been obtained from sources we believe to be reliable, the accuracy and completeness of such information and the opinions expressed herein cannot be guaranteed. This report is for informational purposes only and under no circumstances is it to be construed as an offer to sell, or a solicitation to buy, any security. Any recommendation contained in this report may not be appropriate for all investors. Trading options is not suitable for all investors and may involve risk of loss. Additional information is available upon request or by contacting us at Miller Tabak + Co., LLC, 200 Park Ave. Suite 1700, New York, NY 10166.