Table of Contents:

1) The argument that ultra-low rates justify higher stock prices is quite flawed in today’s world.

2) The stock market IS expensive. Don’t let anybody tell you otherwise.

2a) The odds that the fundamentals will catch up to the stock market are infinitesimal.

3) History shows that the Fed cares much more about the fixed income market than the stock market.

4) It’s an old saying, but it’s very true. The stock market CAN stay irrational for a VERY long time.

5) The infrastructure stocks are getting overbought (& the projects won’t kick-in until 2023/24).

6) The chips stocks (a KEY leadership group) are STILL at an important technical juncture.

7) It sure looks like we’re returning to the “sell growth/buy value” rotation trade.

8) Things that make you go, “Hmmmmmmmmmm.”

9) European stocks: Great run, but they’re getting overbought near-term.

10) Summary of our current stance.

1) The argument that lower long-term interest rates justifies higher valuations is quite flawed. It’s not the lower interest rates that are pushing stocks higher. It’s the liquidity that comes from the Fed’s buying program that is pushing stocks higher. If interest rates were at today’s ultra-low levels due to something other than massive central bank (price-insensitive) buying…and thus were ultra-low for fundamental reasons…the stock market would be much lower.

Over the years, we have all heard people who state things (over and over again) that simply aren’t true. Politicians (from both sides of the aisle) have been particularly guilty of this practice. They know that “perception is reality”….so they repeat the same falsehood again and again…with the hope of changing the “perception” of an issue. Th goal for the politician, of course, is to move the issue from the negative side of the ledger…to the positive side of things…for him/her. They realize that the facts surrounding the issue will not help their narrative, so they bend the truth when they talk about the issue…and they do it endlessly and incessantly…with the hope of changing the perception on the issue (no matter where the truth lies).

Put another way, many politicians believe it is imperative for the continued success in their careers to keep the key narratives as close as they possibly can to one that will be positive for themselves…even if they have to bend the truth (sometimes materially) to reach this goal.

The same thing can happen in the markets. Sometimes, when the truth does not fit the narrative for some people on Wall Street, they bend the truth so that it fits the bullish narrative that so many on Wall Street are paid to follow. One of the most common examples of this taking place is whenever the stock market becomes very expensive. The perma-bulls always try to tell us why “it’s different this time”…OR they try to tell us that the stock market isn’t really as expensive as the facts tell us it has become.

We’re seeing this same kind of “truth bending” on Wall Street once again this summer. We’ve heard a lot of pundits try to claim that today’s stock market is not very expensive. Many of them do admit that the stock market’s P/E ratio is very high, but they argue that these very high multiples are justified due to the extremely low level of interest rates that exists today.

We understand why people say that today’s extreme valuations levels are justified by ultra-low interest rates in theory. The problem is that the reason that long-term interest rates are so low is because the Fed is buying these Treasury bonds in an artificial manner (with zero sensitivity to price). Since the level of interest rates are artificially low, it means that stock prices are artificially high.

No, the reason we say this has nothing to do with the “theory” that lower rates justify higher stock prices. The real reason we say that stock prices are artificially high is because the Fed’s artificial (price insensitive) buying of bonds is what CREATES the excess liquidity…which has to go somewhere. It goes into stocks and other risk assets…which pushes them higher than they would go without this artificial stimulus.

In other words, if the markets were left to their own devices, not only would stock prices be lower due to the fact that higher yields would provide more competition for stocks, but they’d also be lower because there wouldn’t be as much buying power (liquidity) in the marketplace to push stocks this high!

Let’s look at this in another way. What if the Fed stopped buying all of those bonds…and bond yields actually fell for some fundamental reason??? The stock market’s valuation would NOT stay elevated due to theoretical justifications. In that scenario, those those lower interest rates would NOT be creating excess liquidity…like they do in a QE program. They’d merely be signaling weakness in the economy…a flight to safety…or something like it.

The main reason why lower long-term interest rates SEEM to justify higher stock valuations in today’s marketplace is because the liquidity that is produced by the artificial (price-insensitive) buying of those bonds by central banks PUSHES stock prices higher. It’s not the lower interest rates that justifies higher stock valuations, it’s the liquidity that that those artificially low rates provide…that PUSHES stock prices higher.

Again, if interest rates were at today’s low levels for fundamental reasons, the stock market would be much lower. In other words, if long-term interest rates were sitting at today’s ultra-low levels due to fundamental reasons…and NOT because the Fed was buying them hand over fist…it would mean that real investors were buying Treasuries hand over fist. THAT, in turn, would mean that the bond buying was NOT creating massive levels of liquidity in the system. Therefore, it would not keep the supply/demand equation heavily towards the demand side of things…like it does when the Fed is buying the bonds (as they are today).

2) We do not understand how people can try to say that today’s stock market is not expensive. In fact, it scares us that they keep stating this crazy argument…because it’s the same argument we heard in 1999 and 2000…and again in 2007. We all know how things turned out after that.

Some pundits do not even admit that today’s stock market is expensive at all. They are trying to say that the 22 multiple that exists right now is really not very expensive. They say that the average multiple for the S&P 500 Index over the past 30 years is 20x forward earnings, so we’re not far off. Well, very simply, that’s just not accurate. The average multiple over the past 30 year is 17.5x forward earnings, NOT 20x.

(It’s weird, we also keep hearing some people try to say that today’s multiple is just 20x earnings. The S&P 500 is trading at 4,468…and the consensus estimate for the full year is $200. Therefore, simply math tells us that today’s P/E ratio is 22.34x forward earnings.)

In fact, if you take out the bubble years of 1998 through the 3rd quarter of 2000 (when the S&P topped out), the average P/E ratio has been 16.5x forward earnings over the past 30 years. (The P/E ratio averaged 24.4x during those bubble years of the late 1990s.)…… Then again, if we’re going to include the bear market years when the P/E ratios fell to extremely low levels, we should include the years when the stock market was indeed in a bubble.

Either way, the average historical P/E ratio for the S&P 500 has been MUCH LOWER than where the market’s multiple stands today. For the S&P 500 to be trading at its accurate average multiple of the last 30 years, it would be trading at 3,500. Heck, even if you use the highest estimates on the Street for 2021 ($220), that would still leave the stock market vulnerable to drop to 3,850 to reach its average multi-decade P/E ratio. THAT would take the market down about 14% from current levels.

Of course, earnings can be gamed…so the P/E ratio is suspect anyway (and it’s not suspect to the downside). However, sales cannot be gamed. They are what they are. (The only way to change them is to outright lie.) Therefore, it is a much better measure of the stock market’s valuation. Guess what, the price-to-sales ratio is MUCH higher than it was at the top of the 2000 bubble! So those who say this market is not expensive are out of their minds in our humble opinion.

What we’re saying is that one of the key reasons why the stock market has reached its current level has to do with issues outside the arena of fundamentals. In other words, the Fed has played an important hand in pushing stock prices to the extreme levels they stand today.

No, we are NOT saying that the ONLY reason why the stock market has rallied so strongly since the global central banks started injecting their massive levels of stimulus in March of 2020. The economy IS doing MUCH better than it was 12-18 months ago…and earnings are reaching record levels. We’re just saying that the stimulus/liquidity that the central banks have been providing has taken the market to an artificially high level…a level that it would not have attained on its own.

In other words, a very strong rally off the March 2020 lows has certainly been justified. We’re merely saying that the rally we have experienced has been stronger than can be justified by the improvement in fundamentals we have seen so far (or are likely to see in the next 12-18 months). It has been juiced to an artificially high level. Therefore, the stock market (and other risk assets) should come-back down if/when that stimulus/liquidity becomes less plentiful in the future.

2a) It’s great to say that the fundamentals are playing catch-up to the stock market. However, that’s very difficult to do if the stock market keeps rallying. More importantly, whenever the stock market has become as expensive as it is today, the fundamentals have never been able to fully catch-up with the market. The market has always fallen back to meet the fundamentals.

There is one other strategy that those who are paid to be bullish sometimes follow. They admit that the stock market has become very expensive, but they also say that the fundamentals can play catch-up to the extended level of the stock market. The problem with this argument is that it has NEVER worked! Whenever the stock market has become as extremely overvalued as it is today, the market has always dropped in a meaningful way to meet the fundamentals. The fundamentals have never jumped up enough to meet the level of the stock market that made it “fairly valued”.

We do admit that it COULD indeed end up being “different this time.” Let’s face it, given the pandemic…and the monetary & fiscal stimulus that has been implemented to fight it…have provided an environment that is different than anything we have faced in the past. We also admit that the fundamentals HAVE been playing catch-up to a small degree this year. However, for fundamentals to catch-up with a stock market that keeps rising at a double-digit rate, we’d have to see an economic boom unlike any other in history.

Therefore, the odds that the fundamentals will catch-up to the stock market are very low. We do suppose that there is an outside chance that the fundamentals will play catch-up with a flat stock market over several years. However, THAT would not be great for investors. Having said this, it would certainly be better than what history tells us is the best we can hope for…which is that they’ll meet somewhere in the middle…after a deep correction in the stock market.

3) We believe that there is a major misconception that exists among investors when they think about the Fed. The vast majority of investors think that the Fed has been providing a “safety net” (or even a “hard floor”) below the stock market for many years. That WAS true in the first five years or so following the financial crisis. However, since then, the Fed has really only cared about fixed income market. If the stock market were to go down…and not have a serious (negative) impact on the fixed income market…the Fed would go ahead and let stocks fall in our opinion.

In the years following the financial crisis of 2007-2009, the Fed readily provided very high levels of liquidity. Long after the stock market bottomed in 2009, the financial system stood on wobbly legs. Thus, it was quite appropriate for the Fed and the other global central banks to engage in QE programs and other stimulative measures for quite a few years a decade ago. On a few occasions, the central banks believed they could end their programs and let the markets move on their own. However, for several years following 2009, each time they pulled-back on QE, the markets (and the system) became very fragile very quickly.

However, by 2015, they thought they could finally begin taking the punch bowl away. They raised short-term rates in December of that year. The problem was that this is when the oil markets fell very hard. When that took place, the high yield market began to melt-down (in late 2015). This lasted into early 2016 and thus the Fed decided not to keep raising rates after their first hike. They needed to let the high yield market stabilize before they became restrictive in a more meaningful way.

Then, at the end of 2016, the Fed started tightening once again…with more short-term rate hikes. These hikes kept coming on a regular basis. As it usually does, the stock market ignored these rates hikes for many months. However, eventually, it had a negative impact on the stock market (just like it always does…eventually). HOWEVER, the Fed did not care. As we moved through the second half of 20218, they kept on raising rates. In fact, it the middle of December 2018, they raised rates even though the stock market had fallen WELL INTO correction territory…and Chairman Powell said at the time that they were going to continue to raise rates for the foreseeable future.

HOWEVER, shortly after that December 2018 rate hike, the high yield market began to fall out of bed again. At the same time, credit spreads began to widen in a meaningful way. It was then…ONLY AFTER THEY SAW SOME SIGNIFICANT STRESS IN THE CREDIT MARKETS at the very beginning of 2019…that they decided to engage in their famous “pivot”…and quickly reversed course. In other words, when the stock market was getting hit hard in December of 2018, the Fed did not show any concerns at all. It was only after the situation spilled over into the credit markets that the Fed became concerned and shifted course.

We’d also note that the Fed committed to a “not QE” QE program in the fall of 2019. (They said it was not QE, but it was. We like to call it the, “Not QE,” QE program.) This time it was when the repo market that caused the problems when it started to freeze up in September of that year. So, it was another situation where some stress in the fixed income market caused the Fed to act. (It also led to a surprisingly strong rally in the stock market into the end of the year in 2019.)

We could also say that the real reason the Fed moved with such massive force in March of 2020 was because the fixed income market had frozen up. However, since both the equity and fixed income markets were seeing massive levels of stress at that time, we cannot say that it was only the fixed income market that caused them to act so forcefully.

Of course, some people could argue that a significant fall in the stock market would likely CAUSE some stress in the fixed income market (like it did in late 2018). Therefore, they argue, it is in the Fed’s best interest to keep the stock market elevated. This argument would go on to say that the Fed will keep the stock market elevated IN ORDER to keep the fixed income market stable.

We understand why people would follow this argument, but we question if that entails keeping the market from experiencing ANY kind of correction. We seriously doubt it. Corrections are normal and healthy…so we believe the Fed actually embraces them…as long as they do not cause a significant problem for the fixed income market.

We could certainly be wrong. Maybe the Fed insists on keeping the stock market elevated (and rallying further) because the system is still SO stressed that the fixed income market could not even take a correction of 15%-20%. However, we did notice that the Fed quietly announced a new standing repo facility. This has been explained away by several pundits, but we wonder if they are worried that a disruption in the stock market (or some other market) could cause a problem in the fixed income market in the months ahead…and they want to get ahead of it.

Maybe this kind of facility will allow the Fed to let stocks finally pull-back in a normal and healthy fashion…because they’ll have a program in place to keep the fixed income calm if the stock market corrects……….Okay, okay….that sounds way too conspiratorial to be true. However, it is our considered opinion that the Fed cares a lot less about the stock market than most people realize. In fact, as we continue to say ad nauseam, corrections are normal and healthy…and thus if one can take place without it disrupting the fixed income market in a significant way (and thus not disrupt the financial system), the Fed will be all for it in our humble opinion. (Getting rid of forth is always healthy for the markets…as long as it’s done early enough.)-

4) Havings said all this, we have to admit that the stock market is obviously ignoring these valuation issues (and other issues) that have raised our concerns in recent months. Therefore, it could keep on rallying for a long, long time……Heck, even though the forward P/E on the S&P stands at 22.3, that’s exactly where is stood in August of 1998…and the S&P rallied ANOTHER 40% over the next two years! So let’s look at some items on the bullish side of the ledger.

One of the oldest saying on Wall Street is that the stock market can stay irrational longer than you can stay solvent. When you combine this with the fact that history tells us that the stock market usually goes up when you look at it over many decades…and we can all understand why so many people on Wall Street are willing to remain perma-bulls throughout all of their careers. (As one bulge bracket strategist once said, “It’s much better for job security to be bullish and wrong…than bearish and right.”)

Since the stock market just might stay expensive…and even get more expensive…let’s look at the bullish side of the ledger. First and foremost, earnings have been spectacular this year. In most years, earnings estimates for the S&P 500 start at their high for the year…and spend the rest of the year declining. THIS YEAR, however, they have risen in a significant way. The full year estimates in January were running in the mid $160’s for the S&P. Now, they’ve jumped to $200! (If the stock market had remained flat this year, the S&P would be trading at 18.8x earnings. That would still be on the high side, but not extremely expensive.)

Therefore, since the earnings picture continues to rise nicely, it is quite understandable that investors want to keep on buying…even though history tells us things are becoming much riskier today……It’s also understandable that institutional investors want to keep on buying. They cannot be raising cash if the market is rallying. Their careers…or at least their bonuses…depend on them keeping up with the market. (It’s funny, institutional investors can lose money without worrying too much…as long as they don’t lose more than their competition or have their returns fall further than the market declines. However, they can actually lose their jobs if they make money…even if they make a lot of money...if they fall too far behind the market and/or their competition.) When the market is rising, institutions HAVE to keep buying. Today’s market is obviously rising, so that’s bullish….pure and simple.

Another item on the bullish side of things is that money keep flowing into the marketplace. Goldman is reporting that the inflows for 2021 are on pace to be 40% higher than the previous 25 years combined!....The only problem with this one is that money flows are not a leading indicator. The market is the leading indicator for money flows, not the other way around….That said, until the market reverses for one reason or another, we have to acknowledge that a rising stock market and rising money flows can feed on one another for extended periods of time.

We’d also note that although the stock market is overbought, it’s not as overbought as it has been on several other instances in the past. We’re not just talking about 1999/2000. The weekly RSI charts on the major averages were more extended in early 2020, early 2019, mid-2013, and early 2011. (Chart below)

Also, although sentiment is quite bullish, several of those readings that we follow have become more extreme than they are right now before the market rolled over. The Investors Intelligence data shows that bullishness is up at 56%. That’s high, but it’s not even the high for this year. (It got to 60% in April.) We also note that bullishness among futures traders is in the high 80s, but we’ve seen it move into the low-to-mid 90s before it has signaled an important top in the past.

What we’re trying to say is that we do not agree with those who say that the stock market is cheap (or even fairly valued)…and we thus we do not believe that economic/earnings growth alone can take the stock market higher from current levels. HOWEVER, there are certainly items on the bullish side of the bull/bear ledger…and thus the market could continue to rally for some time to come.

5) The passage of the infrastructure bill by the Senate was a positive development. However, it still has to pass the House. Also, a lot of these stocks are getting quite overbought on a near-term basis. On top of this, Administrations almost always back-end loads their fiscal plans to the last two years of their term, so we need to be careful about chasing many of these stocks up at these levels.

We need to be a bit careful about chasing some of the stocks that will benefit from the new infrastructure package that was passed by the Senate. First of all, it still has to get through the House. No, we don’t expect an incredibly long wait for the House, but it’s not a lock that it will pass quickly. However, there are two other reasons why we worry that these stocks might not act as well over the rest of this year as many/most people are expecting right now.

The first issue is that many of the stocks have already rallied very strongly and thus have already priced-in a lot of the benefits these companies will receive from their coming government contracts. The recent rally in these names have also taken many of these stocks to levels that are quite overbought. Look at Deere (DE) for example. It has seen a nice run, but it is getting overbought on its RSI chart. This does not guarantee that DE is going to roll-over immediately, but it just seems like this stock (and others related to infrastructure) are getting ripe for at least a “breather” at some point soon. (DE chart below.)

However, there is another reason to worry about these infrastructure plays. If these projects are ANYTHING like they’ve been in the past, they will be back-end loaded. In other words, the real economic benefit will not come until 2023 and 2024. The Biden Administration will do what most Administrations have done in the past. They’re make sure that their new fiscal programs will kick-in during the 3rd and 4th years of the new Administration…so that it will help the economy in the years that they are running for re-election.

(No, President Trump did not back-end load his programs. That led to a very strong economy early in his term…and look where that got him. Presidents Reagan, Clinton, and GW Bush…all had recessions early in their first term. Yet, they were still able to get re-elected…because the economy had recovered by the time their re-election bids came around. Do you think that the Biden Administration is going to front-end load the infrastructure programs given this history???)

Don’t get us wrong, the fact that these companies will be making a lot of money in future years is still positive news for their fundamentals. In fact, even though these projects might not flow-through to company earnings for 2-3 years (instead of 1-2), investors would likely still be willing to buy the stocks…even though they won’t feel the positive impact of the increased spending for a while. However, since many of these stocks have already rallied so strongly…and have also become quite overbought on a near-term basis…chasing these infrastructure names up at these levels might not be a great idea. Instead, investors might want to look at them on pull-backs.

We do want to add one more item. The fact that the implementation of the infrastructure programs are likely to be pushed-out for a while is probably more important in trying to predict overall economic growth in 2022 vs. 2023 & 2024 (growth in 2022 is unlikely to get much benefit from it)…and thus people have to be careful about using this development as a key reason to be bullish on growth for next year.

6) We apologize for harping on the chip stocks so often, but we actually have not commented on them in a couple of weeks. However, we did get some news last week, so we want to touch-on them once again. It looked like the semis were going to breakout this month, but the weakness in the group last week raised some further questions. Therefore, the group is still at a key technical juncture.

Last week, Morgan Stanley downgraded on of the leading semiconductor stocks, Micron Technology (MU). They warned that “winter is coming” for the global memory chip sector. They sighted the loss of demand for chips, saying that the their cycle indicator had shifted out of “mid cycle” to “late cycle.” Later in the week, Evercore ISI took MU off their “Top Picks” list as well……This news pushed MU down by almost 14% last week. The stock was already down 13% going into the week, so there is no question that MU has completely lost the upside momentum it had experienced since the March 2020 lows.

The problem is that the reason for the downgrades on MU were not company specific, therefore this news had a negative impact on the entire group. The decline in the SMH semiconductor ETF was not a major one last week. However, it did take it back down to the top-line of the sideways range the SMH had been in for six months leading into August. In other words, if the group falls further over the coming days and weeks, it’s going to tell us that the breakout that we saw earlier this month was merely a “head fake”…and that this important leadership group is in a bit of trouble.

The development that concerns us the most on the technical side of things is that the MACD chart on the SMH saw a negative cross last week. It is only a relatively mild cross so far, but if it becomes a more pronounced one, it’s going to raise some important concerns about the group. The reason for this is that the SMH has seen a negative MACD cross seven other times in the past 12 months…and each of them was followed by a meaningful pull-back (and some of those declines have been outright corrections).

Having said all this, the “old resistance” level of 260 on the SMH is now “new support.” Therefore, if the chip ETF can bounce quickly…and avoid a more meaningful negative MACD cross…and if it can then break above its August highs in a significant way, it’s going to be very bullish for the semis. In other words, there is no question that this group still stands at a very KEY technical juncture…and it’s next big move should be a VERY important one.

7) It is amazing to us that a very wide discrepancy has developed between the opinion on Wall Street about the effect the variants of the coronavirus will have on the economy going forward. There are always bullish and bearish opinions on all issues facing the markets, but one usually has a big majority following, while the other opinion is held by a minority. This time, the two opinions on the variants BOTH have wide followings. Whichever opinion is correct should be important as to how “group rotation” plays out the rest of the year…..Also, we have to consider the possibility that interest rates could be higher at the end of the year no matter who is correct on this issue!

It is interesting to see/hear the big divergence that has developed recently between the bullish and bearish opinions on the variants of the coronavirus. On the bullish side of things, we’re hear some health experts say that this the current “wave” of Covid will be the “last wave”…and comments like these are leading some market pundits to say that risk assets in general are going to rally significantly into the end of the year.

On the bearish side of the ledger, we have reports of big increases in cases in several parts of the U.S. We are also reading stories about Tokyo leaders saying that the “virus situation is out of control.” More importantly, China just partially shut down the third busiest container port in the world. This will further strain a global supply chain that has already been under considerable stress for a lot longer than most people had been thinking just six months ago. In fact, this newest development has taken things to the point where it could have a serious impact on the holiday selling season this year.

So, what’s it going to be? Is the Covid issue going to die down and enable the economy to continue to expand at a stronger rate…or are the variants going to cause enough restrictions around the globe to slow the rate of growth we’ve seen for the past several months?

Well, we’re not doctors or scientists (something a lot fewer people on Wall Street have been willing to admit in recent weeks), so it’s impossible for us to know for sure. However, we also have to consider one other possibility. We could see a situation where the variants do become a problem for an extended period of time, but the problems it causes in the supply chains creates higher prices and higher inflation. In other words, the third possibility to consider is stagflation.

Just look at the situation we just mentioned about China. We already have reports where shipping container costs have risen from the $800 range to the $10,000 range. (That’s not a typo!) If these variants are going to cause even more supply chain disruptions, “higher costs” for businesses are going to be with us for A LOT longer than many people are predicting right now. Therefore, there is a strong possibility that any slow-down in growth that results from variant-related curbs/lock-downs will actually lead to an INCREASE in inflation, NOT a softening of it!

In other words, it is our opinion that EITHER WAY, inflation is likely going to be a problem for the rest of this year (and into next year). Only a surprising new crisis that isn’t on anybody’s radar screen right now will cause a meaningful easing of inflationary pressures in our opinion. Therefore, long-term interest rates should continue to rise. With this in mind, we believe that the “rotation trade” we’ll see for most of the rest of this year will be one that consists of rotating into value and away from growth…like we saw from August of 2020 until March of 2021.

8) Every once in a while, we see something that makes us say, “hmmmmmmm.”…..The yield on the 10-year note pulled-back on Friday and it created a key resistance level to watch for long-term yields over coming days and weeks. However, there was another development that caught our eye as well…and it might be telling us that long-term interest rates are going to stay quite low for the next several years.

The yield on the 10yr note saw a decent sized drop during Friday’s session…and this took the yield slightly back below its 200-DMA. We do not see this as a compelling development…at least not yet. The 10yr yield had seen a big jump over the previous seven trading sessions, so the fact that it pulled-back after the much weaker-than-expected consumer confidence data was not a huge surprise. Besides, the markets were very quiet and “thin” on Friday (as they frequently are on Friday’s in August), so it’s hard to put a lot of weight on that one-day move.

However, we would note that the recent rise in the 10yr yield stopped right at its 50-DMA. That line provided tough resistance in late May and in June. Therefore, if it can finally break above that level, it’s going to add to the argument that says the 4–5-month trend of lower interest rates had come to an end…and that rates are headed higher into the end of the year.

That said, there was an interesting development that took place in the options market last week. There was some serious volume in the Eurodollar options market last week. More specifically, there was a lot of buying of Eurodollar call options that expire in March of 2025 which target 3-mos Libor to fix below 0.5%.....This was quite interesting because the futures market right now is pricing-in that Libor will rise to almost 1.5% by early 2025.

This is reminiscent of what we saw in the options market in late 2019 and early 2020. However, this involved the VIX call options…which were purchased in a substantial way. Back then, we thought these call buyers were probably looking for the Covid issue to become a big problem. (Whether that’s what the were betting on or not, we don’t know…but those bets became extremely profitable.)

What are the options buyers betting on this time around? Are they betting that the variants will cause another surprising big problem…or something else? Who knows! We also don’t know if these bets will be profitable ones…like those VIX options were last year. However, given the size of these bets, it was certainly something that made us say, “Hmmmmmmmmmm” to ourselves last week…..For us, we think interest rates are headed higher, but this development made us pause a little bit last week.

9) We’re heard a lot last week about how well European stock markets are doing. That’s great…and it might mean that those stock markets will do very well over the rest of this year. However, they’re becoming overbought on a short-term-basis, so we believe that investors should avoid chasing these stocks up at these levels. You should be able to buy them at lower levels in the weeks ahead.

There was a lot of talk on Friday about how the European stock market has rallied 10 days in a row. That’s great, but it has taken the STOXX Europe 600 Index to a very overbought level. Its weekly RSI chart is now the most overbought it has been since 2006! Therefore, it is going to be tough for this market to rally a lot further over the near-term. In fact, it should see a bit of a pull-back in order to work-off this overbought condition.

Don’t get us wrong, the STOXX Europe 600 Index has broken very strongly above its key 460 resistance level this month, so that’s quite bullish on a longer-term basis. However, when you combine what we just highlighted about its weekly RSI chart…with the fact that it’s now at its highest premium to its 200-week MA since 2015, there are reasons to be careful about European stocks on a short-term basis. Heck, after rising 10 days in a row, it would be normal & healthy for the stock markets from across the pond to take a breather.

10) Summary of our current stance……We continue to be cautious about the stock market’s potential as we move towards the seasonally weak September/October time frame. Valuations remain extreme…sentiment is getting high…and the stock market is overbought. These readings are not a reached major extremes, so the market could still go a bit higher over the very-near-term, but there is no question that the risks in the market place have grown substantially this summer.

On top of this, we have record levels of leverage in the system. At some point, at least some of that leverage will have to be unwound…and this is why we believe that any correction will likely evolve into a deep one.

Another concern for us is the issue of stagflation. The supply chain disruptions have not gotten much better. In fact, in many cases it has become quite a bit worse. Given what we’re hearing out of China, this problem is not going to go away ANYWHERE near as quickly as most economists thought at the beginning of the year. The problems that will result from this issue (which include possible stagflation) should create headwinds for the economy for an extended period of time.

Of course, we still have the issue of the Fed’s stimulus program. It sure looks like the Fed is continuing to follow the 2013 script. The Fed Chairman has remained quite dovish…while the list of FOMC members to switch to the hawkish side of the ledger grows. (Last week, we added Waller to the group that includes Bostic, Bullard, Kaplan, and Rosengren…while Vice Chairman Clarida moved a little closer to the hawkish side). However, they certainly seem to be heading for a move to taper back on their bond buying program.

We want to reiterate something we said in one of our daily comments last week. We think that the Fed has done an UNBELIEVEABLY great job in helping us ride out the pandemic “storm.” However, even if the storm is not over, it has certainly been downgraded from a Category 5 hurricane, so we believe that we no longer need the kind of emergency stimulus that the Fed has continued to provide.

To be honest, we do not think that an announcement from the Fed about tapering will be a significant catalyst for decline in stock prices. It is more likely that some sort of surprising news will provide the spark. It could be interest rates…but it could be something out of China…or geopolitical development out of Afghanistan or China. (Lots of reasons to be worried about China.) However, there is no question in our minds that the risks of a correction have grown dramatically over the past five or six months.

The cherry on the top of the ice cream for us has been the plethora of excuses that are being put forth that say the traditional signs of a top don’t matter anymore. A common comment is becoming, “You could have said that at any time over the past year”…which is exactly what we heard throughout much of 1999 and 2007.

However, even though we just used the 1999 and 2007 examples, we’re not necessarily looking for a similar kind of (50%) bear market. The Fed seems to be ready and willing to do whatever it takes to keep the kind of horrible drop in stock prices that will create problems in the fixed income market from taking place. However, that does not mean that they can (or even want to) stop every (normal and healthy) correction in the stock market from taking place. In our opinion, if the people at the Fed are as smart as we think they are, they would actually LIKE to see a correction of 15% or more in the stock market…as long as it did not disrupt the fixed income markets in a substantial way.

If their goal is financial stability (which entails a stable fixed income market…much more than it entails a rising stock market), taking some froth out of the marketplace right now (before it’s too late) would actually be the prudent thing to do in our opinion.

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.

Posted to The Maley Report on Aug 15, 2021 — 10:08 AM
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