Bullish borrowers have increased their margin debt to invest in stocks from $445 billion in January to $507 billion today. And why not? The overall price movement for growth sectors of the stock market remains healthy.
Flashy sub-segments like cyber-security and biotech continue to soar. For example, I allocated a small portion of moderately aggressive client assets to the Pure Funds ISE Cyber Security ETF (HACK) in early February. Its series of higher lows since its inception lent credibility to the notion of adding dollars to the high growth, high reward area.
Yet the belief that U.S. equities can stampede ahead indefinitely is sheer lunacy. Consider the reality that exports have been tumbling, labor productivity has been stalling and inventories (supply) have been rising significantly faster than sales demand. No matter how the media spin it, the economy is hurting. Now factor the economic headwinds into current and/or future corporate profits and revenue. What do you get? You come up with some of the highest price-to-sales (P/S), price-to-book (P/B) and price-to-earnings (P/E) ratios in the history of stock market valuation.
Who cares, right? “Follow The Fed” advocates argue that global central banks have orchestrated exceptionally easy terms for borrowing, making bonds unattractive and stocks the only place to stash money. They maintain that modest rate increases amount to little more than moving from ultra-accommodating policy to extremely accommodating policy. Still, amateur historians might wish to recount that rate hikes in questionable economic environments (e.g., 1929, 1948, 1980) were met with recessions and stock market bears. Others might want to address the historical truth that the epic collapses of the previous decade (i.e., 2000-2002, 2007-2009) occurred alongside a Fed that had been cutting rates aggressively.
Might I be more inclined to yield to a “don’t fight the Fed” reasoning if the 10-year were pushing 1%? I imagine I would be buying the harsh pullback that likely occurred along the way. If the 10-year were hugging 2%? I might expect stocks to hold serve. In contrast, the higher the 10-year climbs due to fears of an imminent tightening campaign, the more likely rate-sensitive stock assets will drag the broader market downward.
Remember, the S&P 500 has not witnessed a 10% correction in roughly four years. On the other hand, several rate-sensitive areas have already entered 10%-plus correction territory. Real estate investment trusts in Vanguard REIT (VNQ) are off -11.4%, while utilities in the SPDR S&P Sector Select Utilities have dropped -13.2%.