There’s a court case going on right now in the Southern District of New York.
Not the one involving former president, Donald J. Trump (Editor’s note: There’s more than one!).
This one is far more important.
To show the gravity of what’s at stake, we quote directly from the legal arguments:
It’s the difference between buying Beanie Babies Inc. and buying Beanie Babies.
The argument was from William Savitt, a lawyer for Coinbase Inc (COIN).
Coinbase is fending off a lawsuit from the Securities & Exchange Commission (SEC) which claims Coinbase is guilty of selling unregistered securities.
Coinbase argues otherwise. Claiming that buying a crypto token doesn’t provide ownership in a security. They claim it’s more comparable to owning a Beanie Babie as a collectible… or baseball cards, and so on.
The case continues. We’ll watch with interest. Meanwhile, while the ups, downs, ins, and outs of crypto have been all the rage the past couple of weeks… there are arguably more important matters on investors’ minds.
Mostly, given the rocky start to the year for stocks, which way should you turn? Should you be bullish? Bearish? Neutral?
We’ll give our take below as well as the signs that may help point the way. First, we check in on today’s market action…
Market Data
The S&P 500 closed up 0.9% to end the day at 4,780.94… the NASDAQ gained 1.4% to close at 15,055.65.
In commodities, West Texas Intermediate crude oil trades at $74.10, up $1.39…
Gold is $2,024 per troy ounce, up $16…
And bitcoin is $40,862, down $1,767 since yesterday.
Now, back to our story…
The People Want 5%
Returning to our story of whether this is a bullish, bearish, or neutral market, there are (as we see it) two reasons to be bullish.
Naturally, a bullish market isn’t assured.
Simply because there’s another factor that, while it doesn’t scream bearish right now, is showing cause for concern.
But more on that later.
First, let’s look at the case for the bulls. The first is the argument about investor cash that’s “sitting on the sidelines.”
It’s often easy to dismiss that argument. After all, if you listen to the “perma-bulls” (those who think markets should only ever go up) long enough, they’ll always claim there’s money “sitting on the sidelines,” just waiting to flow into stocks.
And so it was with a touch of skepticism we began reading the following story in today’s Wall Street Journal (WSJ), headlined “The $8.8 Trillion Cash Pile That Has Stock-Market Bulls Salivating.”
The story goes that as the Federal Reserve increased interest rates over the past two years, money left stocks and went into bonds, money-market funds, or CDs (certificates of deposit).
That much makes sense. After all, when interest rates went up, we heard those stories from Wall Street. We heard the arguments that if rates went any higher, it would make stocks less attractive.
So it happened. Money investors moved money out of stocks. Stocks fell.
But since the market rebounded from the lows last October, it’s reasonable to think all the money that flowed out hasn’t yet flowed back in.
As the following chart we pulled from the article shows:
Sources: Wall Street Journal, Federal Reserve, Federal Insurance Deposit Corporation
As of the last data snapshot – September 2023 – you can see there’s nearly $9 trillion in savings in cash or cash-like investments. It’s at the highest level ever.
(Editor’s note: Of course, these numbers aren’t adjusted for inflation.)
But it’s one thing listening to the vested interests – those on Wall Street. It’s another thing to take note of what regular investors have to say.
And from that WSJ story, we got a snapshot of what regular folks are thinking now about where to put their money. The view (from an admittedly small sample size) is that they’re not quite ready to leave behind secure 5% or 5.5% interest rates to get back into stocks.
But if those interest rates fall below 5%… and perhaps edge closer to 3.5% or 4%… well, that could be a different story.
Let’s check on how those rates look now. The following is a chart of the five-year bond yield going back three years:
As you can see, bond yields have fallen from last year’s peak. Although still nowhere near the 1% or lower rates we saw a few years ago.
But arguably, rates won’t need to go that low. As the folks interviewed in the WSJ noted, they like 5% on CDs. As long as they’re getting that, there will be less temptation for stocks.
But if rates continue heading lower, this could be one bullish reason for those folks (and others) to get back into stocks.
What other reasons are there to be bullish?
“Secret” Debt Market
A niche segment in the debt market is one potential sign. As Bloomberg headlines, “Private Lenders Are Opting to Go Public After Valuations Jump”.
The article specifically refers to BDCs – or Business Development Companies. Put simply, BDCs are companies that loan money to small and medium-sized businesses.
The BDC will loan to several businesses different amounts over various terms. This helps to spread their risk. An example of one BDC is Blue Owl Capital (OWL). It trades for just under $15 and has paid 55 cents in dividends over the past year.
That gives it a trailing yield of 3.7%. But folks who bought around $10 last May are on an effective yield of 5.5%. And if the BDC can keep growing the dividend, maybe this is the kind of investment that draws some cash back from the sidelines.
The fact these BDCs are choosing now as the time to list some of their funds on a public exchange should be a good sign. It shows that even in a small way, there is an increased appetite for risk.
Because buying a BDC isn’t the same as buying a corporate bond of Microsoft (MSFT), Apple (AAPL), or Walmart (WMT). As mentioned, BDCs tend to lend money to small and medium-sized companies.
For instance, this week, the Kroll Bond Rating Agency rated one of Blue Owl’s unsecured notes as a BBB. For such a rating, Kroll advises investors that the investment is…
Determined to be of medium quality with some risk of loss due to credit-related events. Such issuers and obligations may experience credit losses during stressed environments.
A BBB rating is the fourth highest rating level on Kroll’s scale. It has 10 rating levels altogether.
As you can see, it’s an investment that comes with risk. Yet there is an appetite among investors for more of these deals. That doesn’t feel like a market where investors are keeping their wallets completely shut.
In the grand scheme of things, it may not be a particularly significant sign. But it’s a sign that, even if only on a small scale, risk is making a comeback.
Finally, the bearish case.
“People are too complacent”
We like to think of ourselves as an optimist. Throughout our career, we’ve tended to focus on exciting growth ideas: tech, small-caps, emerging markets, and the like.
But as much as we enjoy the exciting stories and the opportunities to build wealth from big trends and innovation… we can’t help but take note when folks show us evidence of why we should be nervous.
A case in point this week is from colleague, Chris Weber. We shared an essay of his with you earlier this week.
In his recently published research report, Chris advised his readers to keep an eye on the VIX (volatility index).
We won’t get into all the details of how the VIX works. But in short, investors see it as a measure of how concerned or otherwise they should be about the market.
When the VIX is high, it reflects the high level of volatility in the market. When the VIX is low, it reflects the relatively low volatility in the market.
Because of that, when the VIX is low for an extended period, some see this as the proverbial “calm before the storm.” So, in a way, the VIX behaves as a counter-indicator in that a low level of volatility isn’t always a good sign.
Here’s what Chris Weber told his readers this week…
People are too complacent when it comes to stocks. After a great year, and after a series of great years (excepting 2022) people are back to thinking that stocks have nowhere to go but up. Or rather to continue to go up.
This has been a worry of mine for a while, but last week, when the S&P 500 tried twice to get to new highs and failed twice, this feeling only got worse.
The averages did get to records during the day but could not continue to the close.
At the same time, the VIX Index, or volatility chart, has been playing around lows that it hasn’t seen for years. To me, this is not normal. In sum, people just aren’t as worried as they should be. We’re coming into a year that is going to see more than its share of drama, and we’re not just referring to the American election.
Money is being drained by central banks around the world. While this is not a bad thing after years of inflation, draining money after years of inflation can have the effect of a drug addict ceasing with the syringe after years of use: there often comes a terrible period of withdrawal.
The most famous of these periods happened when the Fed slowed down its rate of inflation at the end of 1928.
We’re only two weeks into the new year, and the S&P 500 has had a number of big up and down days. But despite that… it’s flat for the year-to-date.
If you fell asleep on December 31 and woke up today, looking at the index you would likely feel as calm as can be. Meanwhile, between those times, most investors have fretted about every hourly and daily move.
So what can you do with this info? Do you ignore the bullish case… or ignore the bearish case and the worry about the VIX?
The short answer is neither. The great part about publishing opposing views (as we do at Legacy Research) is that it’s impossible to get yourself locked in an “echo chamber” where you’re only listening to one point of view.
By listening to opposing views, you get the chance to hear about great investment ideas and trends while also getting the message that perhaps everything won’t be easy.
It’s a great help for your risk management. It prevents you from going “all in” on a hot idea. It also prevents you from scaring yourself into doing nothing.
The truth is, we can’t know for sure how this year will play out. We have our ideas. Our experts have their ideas. And you probably have ideas of your own too.
The key to successfully investing through this period (as with any other) is to take note of all the information you can… and then make rational decisions.
Going all-in on the market is no more likely to be the correct answer than selling everything and hiding away.
We’ve given you two reasons to be at least somewhat bullish for this year and one reason to be cautious.
Our bet is this year’s best investors will use bullish and bearish information in that proportion. That is, a positive year for stocks, but not without a few bumps here and there.
We’ll see exactly how that plays out in the months ahead.
More Markets
Today’s top gaining ETFs…
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Invesco Semiconductors ETF (PSI) +3.4%
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First Trust Nasdaq Semiconductor ETF (FTXL) +3.3%
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iShares Semiconductor ETF (SOXX) +3.3%
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VanEck Semiconductor ETF (SMH) +3.3%
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SPDR S&P Semiconductor ETF (XSD) +3%
Today’s biggest losing ETFs…
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Amplify Transformational Data Sharing ETF (BLOK) -1.5%
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Nuveen Short-Term REIT ETF (NURE) -1.2%
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Utilities Select Sector SPDR Fund (XLU) -1.1%
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Invesco S&P SmallCap Consumer Staples ETF (PSCC) -1.1%
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Invesco Dorsey Wright Healthcare Momentum ETF (PTH) -1.1%
Mailbag
If you have any questions or comments for our experts here at Legacy Research, we’d love to hear from you.
Write to us at feedback@legacyresearch.com and just type “Daily Cut mailbag” in the subject line.
Cheers,
Kris Sayce
Editor, The Daily Cut