One up, two down…
- All is not as it seems
- This could be the quickest market crash in history
- Two crash warning signs
Stocks up again overnight.
But wait. Not all is as it seems.
The price-weighted Dow Jones Industrial Average was up 1.17%.
The market capitalisation-weighted S&P 500 was only up 0.2%.
And the market cap-weighted NASDAQ Composite index was actually down 0.81%.
One index up. Two indices down.
Has the ‘Trump Effect’ worn off already?
Maybe. We’ll look at how and why below…
Overnight, the Dow Jones Industrial Average closed up by 218.19 points, or 1.17%.
The S&P 500 gained 4.22 points, or 0.2%.
In Europe, the Euro Stoxx 50 index fell 9.7 points, or 0.32%. Meanwhile, the FTSE 100 lost 1.21%, and Germany’s DAX index lost 0.15%.
In Asian markets, Japan’s Nikkei 225 index is up 28.69 points, or 0.17%. China’s CSI 300 is up 0.65%.
In Australia, the S&P/ASX 200 is up 41.87 points, or 0.79%.
On the commodities markets, West Texas Intermediate crude oil is trading for US$44.44 per barrel. Brent crude is US$45.84 per barrel.
Gold is US$1,259.45 (AU$1,654.29) per troy ounce. Silver is US$18.62 (AU$24.46) per troy ounce.
The Aussie dollar is worth 76.13 US cents.
All is not as it seems
A 200-plus point gain on the Dow Jones Industrial Average usually means it’s a big day for the market.
But when you look at the tiny 0.2% gain for the S&P 500, it’s easy to see that things aren’t quite as they seem.
We won’t go into a long treatise about the benefits or otherwise of a market cap-based stock index over a price-based stock index, except to say that the former is generally more representative of the true market action than the latter.
For instance, the two biggest movers in the Dow were JPMorgan Chase & Co [NYSE:JPM], which was up 4.64%, and Goldman Sachs Group Inc. [NYSE:GS], which was up 4.28%.
Combined, they contributed nearly 80 points of the Dow’s 218 point rise.
Yet their combined market capitalisation is around US$350 billion.
Meanwhile, General Electric Company [NYSE:GE], which gained a not-insignificant 2.63% for the day, contributed just five points to the Dow’s rise. It has a market cap of US$269 billion.
The reason is that Goldman Sachs’ share price is US$200.87; JP Morgan’s share price is US$76.65, while GE’s share price is just US$30.41.
When it comes to the Dow, the share price — not market capitalisation — matters.
The disparity is clearer when you compare those gains to some of the big losing stocks.
Apple Inc. [NASDAQ:AAPL] has a market cap of US$574.7 billion. That’s nearly as big as the three previously mentioned companies combined. Yet, because its share price is US$107.79, its 2.79% fall only shaved 21 points off the index.
The net result is that three stocks with a market cap of US$619 billion added 85 points to the index, while one stock with a market cap of US$574 billion only deducted 21 points from the index.
That doesn’t mean the Dow is irrelevant. But it does mean you have to take it with a grain of salt when it gains big, and the S&P 500 barely ekes out a gain at all.
What’s more, there’s another reason to be wary when the two biggest gainers are both bank stocks: JPMorgan and Goldman Sachs. And the third biggest gainer is big pharma company, Pfizer Inc. [NYSE:PFE].
Also, on the downside, among the big losers were dividend paying stocks such as Proctor & Gamble Company [NYSE:PG], Coca-Cola Company [NYSE:KO], and Verizon Communications Inc. [NYSE:VZ].
That gives you another clue about interest rates. It means that in order for dividend-paying stocks to remain attractive to investors, share prices need to fall, or dividend payouts need to rise.
If they don’t, investors will ditch those stocks for other, better yielding investments.
You can also see that play out in the sector moves for the S&P 500. Financials were up the most. Dividend paying sectors, such as utilities and consumer staples, were down.
Don’t get us wrong. We love a stock market rally as much as the next investor. But we’re not keen on stock market rallies when it’s only rallying because investors believe stocks will rise, rather than a genuine belief that it’s the result of a strong economy.
This could be the quickest market crash in history
What could rising interest rates mean for stocks?
If the last bull market from 2003 to 2007 is anything to go by, then it means nothing but good things for stock prices. Check out the chart below:
Click to enlarge
The white line is the US S&P 500 index. The red line is the US Federal Reserve’s Fed Funds Rate.
From the low in 2003, to the peak in 2007, the S&P 500 gained 95.5%. That’s a big move. However, by the time the Fed started to raise interest rates, the index had only gained around 42%.
Not only that, but that period of ultra-low interest rates, from the bottom of the market to the first rise, was only a year.
Compare that to what has happened since 2009. As of today, the S&P 500 is up 219%. And the ultra-low interest rates, even if we stop counting from last December’s rate rise, lasted more than seven years.
If we look at the last bull market in isolation, it’s easy to say that higher interest rates don’t necessarily mean stock prices will fall.
But you have to look at the comparison. Stock prices have gone up much more because interest rates were held down for much longer.
So there are two ways you can look at this. There’s the bullish way and the bearish way.
The bullish way would say that if low interest rates created a big bull market last time, then the much longer period of low interest rates should create an even longer lasting bull market this time — after interest rates start to rise.
One year of low interest rates last time resulted in three more years of higher stock prices. They could argue (and we’re sure some will), that seven years of low interest rates should mean 21 more years of higher stock prices!
The bull market will end in 2037.
The bearish argument, as you can guess, will be somewhat less optimistic.
The bearish case will say that you greedy stock investors have already had your bull market. The market only kept rising because it seemed as though interest rates would stay low forever.
The bearish case will say that low interest rates created a whole bunch of malinvestments, which will go sour as soon as rates start to meaningfully rise.
The bearish case will say that if you thought the 2008 market collapse was painful, the next crash will be excruciating.
Oh, and don’t think you have to wait until 2037 for the crash to happen. Bears will argue that once the market hits the peak, the crash will be exponentially quicker than the last one, due to the much larger gain.
As for the timing, we’ll make a bet that Trump’s first nine months in office will be a dream for the markets. Next October, however, that’s when all heck will break loose.
You can quote us on that, too.
Two crash warning signs
Whenever we get worried about the markets, we like to look at two charts. The first is the SPDR BBG Barclays High Yield Bond ETF [NYSE:JNK]. This ETF contains bonds rated below investment grade.
We like to look at this chart because we see it as an early warning sign for a broader market selloff.
Click to enlarge
The ETF is the white line; the S&P 500 is the yellow line. You’ll notice in 2008 and in 2015, the ETF began to fall before the index.
Interestingly, as the index has gained in the past couple of days, the ETF has fallen. That’s due to the prospect of higher interest rates.
Could it also have something to do with the high-risk nature of the bonds within the index…and the viability of the companies standing behind them? We think it possibly could.
The other chart we look at is the Dow Jones Industrial Average compared to the Dow Jones Transportation Average. Here it is:
Click to enlarge
This is relevant to the Dow Theory. The theory suggests that if the Industrial Average hits a new high, but the Transportation Average doesn’t, then it hasn’t confirmed a bull market.
The Industrial Average hit a new high overnight. The Transportation Average is still nearly 6% below its high.
That doesn’t mean stocks will crash. If the Transportation Average gains ground and hits a new high, then the Dow Theory says that this confirms a bullish market.
Until then, we shall watch and see.
Many stocks were up overnight. One in particular was down: Amazon.com Inc. [NASDAQ:AMZN].
It has been down since Donald Trump won the presidential election.
Click to enlarge
Amazon CEO Jeff Bezos supported Hillary Clinton, as did the newspaper he bought a couple of years ago, the Washington Post.
Last December, Mr Bezos posted this on Twitter:
During the election campaign, Trump voiced his displeasure at Amazon. Trump doesn’t like how many of its products are made overseas. He doesn’t like the dominance Amazon has on the online retailing industry.
He promised to look at ways to curtail Amazon if he became president.
It’s no longer an ‘if’, so now it’s a case of whether he’ll do anything or not. The Amazon.com stock price is down 6% since Tuesday’s close.
But, an olive branch appears. Not from Trump, but from Bezos. Jeff Bezos posted this to Twitter yesterday:
Based on the comments from his followers, it looks as though Mr Bezos and Amazon may have lost more customers from this Tweet than they have gained.
The Washington Post reported this week:
‘The Navy called USS Zumwalt a warship Batman would drive. But at $800,000 per round, its ammo is too pricey to fire.’
The US Defense Department had planned to build 32 of the futuristic looking Zumwalt-class ships. But as the costs rose, the number of orders dropped. First to 24…then to seven…and now, finally, to just three.
So far, the USS Zumwalt is the only one to have been completed.
That’s not surprising, at a price tag of US$4.4 billion per ship. Because of that, the amount of artillery required will be significantly less.
Original estimates were that each round of ammunition would cost a staggering US$50,000. But that was predicated on building 32 shops, and stocking each with 600 rounds.
But now the US Navy only needs (or should that be ‘wants’) three ships, the cost per round of ammunition has skyrocketed to US$800,000. That’s the good old laws of supply and demand for you.
Statists will argue that only a national government can be trusted with national defence. We’ve long disputed that claim. This story only confirms that there is nothing — nothing — that the public sector can do better than the private sector.