24 Feb POWELL’S REMARKS WERE INTEPRETED BULLISHLY
The S & P 500 and NASDAQ were posting losses of 1.8% and 3.5% respectively before FRB Chair Powell’s reassuring remarks on inflation and growth. Powell indicated that the Fed was nowhere close to pulling back on its support for the economy. The NASDAQ ended lower about 0.5% and the S & P was flat.
Bloomberg writes “growth shares” are having their worst month against “value” in more than two decades as vaccination campaigns gather momentum and as interest rate rise.
The question at hand is this a beginning of a trend or just noise? As widely known growth has vastly exceed value for almost five years. The last heyday for value was 2000-2005, an outperformance comparable to the current over performance of growth from 2016-2020.
As noted many times the yield curve is steepening. Yesterday another first occurred. The 2-year Treasury auction drew huge demand sending the Treasury instrument most sensitive to monetary policy to all time low yield. For the first time in history the notes were priced at a premium. Because Treasury notes by regulation have a minimum coupon of 0.125%, the auction produced a yield lower than 0.125%.
To place this yield into perspective, the highest coupon rate for a 2-year Treasury was 16.25% sold in August 1981 according to Bloomberg data.
As stated above FRB Chair made reassuring remarks stating the overnight rate is expected to remain at 0.00% until the end of 2022 and asset purchases will continue as planned.
Even with these reassuring remarks and an all-time low yield on the 2-year Treasuries, longer dated Treasuries however again sold off albeit recovered from their lows.
Financial analysis 101 dictates that companies are valuated at expected corporate cashflows discounted by some interest rate. The lower the interest rate, the higher the hypothetical value and vice versa. It was this logic is why the Federal Reserve commented last month that equities are not overvalued based on current yields.
Where is this going? It is generally accepted liquidity is virtually absent but speculation is great. About a week ago I referenced a Deutsche Bank report stating that “call volume as a percentage of market cap of the largest 50 capitalized issues has risen at an unprecedented pace, now representing over 250% of their market capitalization.”
The Bank further wrote it has been steadily rising since March rising from about 50% of market capitalization and is now at “historic hyperbolic proportions.”
As noted many times retail call option buying is intense. Thirty-day old data from CBOE indicated a whopping 81% of call buying is in size of 10 contracts or less concentrated in the largest capitalized issues.
Such intense buying is short term bullish—equivalent to injecting sugar—but typically ends poorly as the option contracts cannot be not rolled over and/or shares don’t rise. Two such examples were last spring’s oil implosion that send crude to negative $38 barrel and the sudden collapse of gold about 10 years ago.
Will history repeat itself but this time in equities and if so by what degree?
I believe the answer will be dictated by interest rates, a view essentially shared by the vast majority of market participants including that of the Federal Reserve.
What will happen today?
Last night the foreign markets were mixed. London was up 0.08%, Paris up 0.11% and Frankfurt up 0.69%. China was down 1.99%, Japan down 1.61% and Hang Seng down 2.99%.
The Dow should open flat and the NASDAQ down about 0.5%. Oil is up another 1.0% to almost $63/barrel as Asian demand is at “record levels” according to the International Energy Agency and lack of capital spending is limiting production increases. The 10-year is off 6/32 to yield 1.37%. The 30-year is down almost a point to yield 2.23%.