3 Things to Watch If The Market Highs Have You Worried
The market is hitting new highs (again) and just about every trader and investor I talk to these days seems nervous, no matter their political slant. For those with a right-wing slant, Biden is a rabid socialist, hellbent on destroying American corporations as he forces a green new deal down our throats. The market is therefore destined to collapse any day! If MSNBC is more your thing, it is a wonder we can still breathe after four years of Trump, let alone function as a democracy, and if we don’t raise corporate taxes quickly, the country will be flat broke in a heartbeat. The market is therefore destined to collapse any day!
If either of those things sound familiar to you, the first thing you need to do is to start leaving politics behind when you consider the market. Keep in mind that we heard the same things from the right about Barack Obama, who presided over a 176% increase in the S&P 500, and from the left during Trump’s four years with a 63% increase in the index.
No, what you should do instead is to put your faith in America’s real strength, its businesses, not its political parties.
Obviously, that doesn’t mean we won’t see a correction. Markets don’t move in straight lines and a drop will come at some point. The question for investors is whether there is any way of knowing when that point is coming or has arrived. There is no one, consistent thing to watch for, because the potential signals change all the time, along with potential problems, so I regularly review what to watch for.
Here are the top 3 things I am watching now:
1. The Fed: The top of the list of things to watch is Fed policy, almost always. Even though politicians would have you believe that their actions control the market, it is the Fed that has fueled this remarkable bipartisan bull run, and it is they who have the power to end it.
The central bank has performed what seems like a miracle since 2009, pumping liquidity into the market and bolstering asset prices, while avoiding inflation. That points to the long-term damage done by the credit crisis and the amount of slack that was in the economy at that time, but eventually, if you keep creating and handing out money, prices of things other than investable assets have to start rising. You can postpone inflation and if you get the timing right, even avoid it, but that timing is about when you tighten policy, not if.
At some point, the Fed will change course, and when they do, the market will react. Even a hint of reduced bond purchases and/or rate hikes will produce a sustained selloff, so that is the number one thing to watch for.
2. Other Risk Assets: As the major stock indices have continued ever higher, so other markets have also climbed to dizzy heights. Bitcoin has a legitimate role and, once it became more widely accepted, was always destined to climb. It was literally designed that way, with inbuilt scarcity and regular halving, but would it be where it is without a ton of excess liquidity in the system? Probably not. The same can be said of other cryptos, and things like NFTs that have value because a lot of things are scarcer than cash these days for the investing class.
Then there are more conventional risk assets, such as small cap stocks and high yield debt. Both have been on tears, with small caps up over 100% in the last year, and the spread between junk bonds and Treasuries heading towards a measly three percent. The last time it was this low was in 2007, and we all know what followed that move.
Other than a change in Fed policy, the most likely catalyst for a reversal in stocks would be a change in attitude to risk. Right now, risk is being embraced in the hunt for a return, but if it starts to be considered a bad thing rather than a necessary one, it will lead to a major selloff of stocks. These markets will give an early warning of that if they start to turn.
3. Growth-Sensitive Commodities: For a while, things like crude oil and copper were considered the number one indicators of broader market sentiment. They were closely watched because the main concern was that global growth would collapse again on a resurgence of Covid, and they would provide an early indication of that.
However, the situation has changed and, while they still bear watching, commodities aren’t the reliable indicators now that they were until recently. Crude is moving more on its supply factors, with a recent drop as the OPEC+ group decided to ease their output restrictions. The demand picture is much clearer now than it was even a short while ago. Vaccinations are happening and are proving effective so while Covid isn’t going away, the chance of more complete lockdowns that would impact the economy is now greatly reduced.
Still, an inexplicable move down in copper and crude together would signal renewed demand concerns, so should be watched for.
It is only natural to get nervous when the major stock indices are hitting new highs every day, but that doesn’t mean that you should be panicked into drastic action on every down day. If things are going to really change, there will be a sign somewhere. So, listen closely to the Fed and keep an eye on risk assets and commodities for otherwise unexplained drops and, in the meantime, understand that politics shouldn’t influence your investment decisions.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.