Last year, at about this time, we turned bullish on the bank stocks. We said that after 2.5 years of underperformance, the group would finally start to outperform the market. There were not very many people who agreed with us. Most, who had been bullish on the group for almost 2 years (while we continued to call for underperformance in the group), they had thrown in the towel earlier in the year that year……A few weeks later (in early October), we turned bullish on the energy sector. We pounded the table on our bullish call…even though just about everybody else on the Street was incredibly bearish on the sector.
Both of these calls have worked out very well over the past year. Yes, both sectors have seen pull-backs, but we’ve been able to recognize those move in advance as well. However, we’ve remained bullish on them on a longer-term basis, and this has worked out incredibly well. Since we turned bullish on the bank stocks, the KBE bank ETF is up over 80%...while the S&P 500 has rallied “only” 38%. Since we turned bullish on the energy sector, the XLE energy ETF had advanced 77% and the XOP oil and gas E&P ETF has gained almost 120%...while the S&P had rallied 36%. Therefore, these calls have been homeruns!
Today, our emphasis is on the broad market…and we are quite cautious. Our one concern with this stance is that the situation is very different from the one we experienced last year. Last year, pretty much NOBODY agreed with our stances on the bank and energy names! Today, many strategists seem to be cautious about the near-term prospects for the stock market. Don’t get us wrong, there are still plenty of bulls out there. It’s just that we have more company with our number one stance right now…compared to last year when we made those two sector calls.
In other words, we’re worried that too many people agree with us for a correction to actually take place! Corrections tend to begin when nobody is looking for them…and that is certainly not the case right now. Having said this, there is one area where we differ from with most other cautious opinions on Wall Street right now. Most of those people who are cautious on the stock market right now say we could see a decline of 10%-12%. We, on the other hand, believe that it could be a much deeper one (15%-20%). In fact, we would argue that it is all but impossible to have a correction of only 10%-12%.
Yes, we could see a 5%-8% pullback, but if the stock market falls 10% or more, it will all but guaranteed a bigger decline. The reason for this is the record level of leverage in the system right now. If/when the stock market falls 10%-12%, it will HAVE to fall even further…because THAT’S when the margin calls will start hitting those leveraged investors. That, in turn, will create at least SOME “forced selling” at that level. Therefore, it will be all but impossible for the stock market to fall 10%-12% without falling further rather quickly.
Anyway, we get another key inflation number this morning…when the CPI comes out at 8:30. We don’t know if it will have a big impact on the markets or not, but there is little question that even though a lot of people are talking about their concerns over inflation, the stock market has not priced-in those concerns yet. Therefore, this issue could/should cause some problems for the market eventually…even if it doesn’t today.
However, there is another reason to be cautious this morning. The overnight repo rate in China hit a 3-month high…as banks are dumping dollars in the swap markets. So as you can see, there are more signs of liquidity stresses in that part of the world.
We have talked a lot about the problems facing the China Evergrande Group in recent weeks. This situation has only escalated, and they are now admitting that they face “tremendous” liquidity strains and they have hired advisors for a looming major restructuring move. In other words, there are other reasons to worry about a decline in the U.S. stock market before long that have little to do with concerns over inflation, stagflation, the Covid variants, slower growth or higher taxes. Therefore, the fact that a lot of people have become cautious on the stock market might not be the kind of contrarian signal that it has been in the past.
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.