Critical To Assess the Market's Risk-Reward Proposition

Leo Kolivakis  |

Image: David Tepper, founder, Appaloosa Management, owner, Carolina Panthers; Stanley Druckenmiller, founder, Duquesne Family Office. Source: Pension Pulse

Fred Imbert and Thomas Franck of CNBC report the Dow rises slightly, but loses more than 2% on week:

Stocks finished Friday with slight gains but the major indexes capped the week with significant losses between a slew of somber economic reports and increasing tensions between China and the U.S.

The Dow Jones Industrial Average advanced on Friday by 60.08 points, or 0.25%, to 23,685.42, but ended the week lower by 2.65%. Earlier in the day, the 30-stock average dropped more than 270 points.

The S&P 500 finished Friday’s session up 0.39% at 2,863.70 while the Nasdaq Composite added 0.79% to close at 9,014.56.

The major averages clawed back their losses throughout the afternoon as retail stocks turned around despite a record decline in monthly retail sales. The SPDR S&P Retail ETF (XRT) rose 2% after sliding more than 1.4% earlier in the session. Best Buy, Kohl’s and Nordstrom rose. Walmart and Home Depot each advanced 2%.

Friday’s turnaround also followed better-than-expected data on U.S. consumer sentiment. The University of Michigan’s consumer sentiment index unexpectedly rose in early May as U.S. fiscal stimulus measures “improved consumers’ finances and widespread price discounting boosted their buying attitudes.”

For the week, however, the Nasdaq Composite and S&P 500 were down 1.1% and 2.2%, respectively, with the latter notching its worst week since March.

“Given the amount of uncertainty about this crisis that still looms, we should not be surprised by the setbacks we’ve seen in markets this week,” said Scott Knapp, chief market strategist at CUNA Mutual Group.

U.S. monthly retail sales fell by 16.4% in April, a record. Economists polled by Dow Jones expected a decline of 12.3%. So-called core retail sales —which exclude auto, gas, food and building materials sales — dropped 15.3%.

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“I guess you could say we knew it was weak,” said John Briggs, head of strategy at NatWest Markets. “The problem is you can’t dismiss all this bad news for April. If you have a deeper hole, you’re starting point is lower.”

Stocks initially tumbled on the retail data. Market sentiment also took a hit amid rising trade tensions between China and the U.S.

The Trump administration moved to block semiconductor shipments to Chinese company Huawei. The Commerce Department said it would “strategically target Huawei’s acquisition of semiconductors that are the direct product of certain U.S. software and technology.”

Meanwhile, Hu Xijin, editor-in-chief of Chinese state-run publication Global Times, tweeted on Friday that China would “restrict or investigate” U.S. companies including Qualcomm, Cisco Systems and Apple if the U.S. takes further action to block Huawei’s supply chain. Hu’s Twitter account was closely followed last year by traders looking for insight on the U.S.-China trade war.

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Shares of semiconductor makers Applied Materials and Skyworks Solutions both declined. Apple shares slid 0.5% while Qualcomm fell 5.1%.

“This is not an ideal time to be ratcheting up the trade war with China,” said Randy Frederick, vice president of trading and derivatives at Charles Schwab. “I don’t really quite understand what the rationale is there.”

“Clearly, the administration wants to see the market do better, but the things they’re doing with China right now are making it worse,” he said.

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There's a reason why Trump is ratcheting up the rhetoric on China: the coronavirus has united Americans in one way, their dislike of China:

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But while Trump is barking at China, so far, there's no bite and the reason is simple. Going into an election, he can ill-afford to go after the Chinese Communist Party even if there are legitimate concerns on how it handled the coronavirus crisis.

In short, I foresee strained US-China relations no matter who wins in November but now is definitely not the time to start another trade war as the US enters a coronavirus depression.

Or maybe it is, you never know with Trump and his advisors.

Anyway, I don't want to discuss Trump, Xi or China, I want to focus on markets.

It seems like the bears infected with monetary coronavirus were back this week but the Fed is still cranking up its balance sheet, so there's a fight between worsening fundamentals and ample liquidity.

Not surprisingly, the Fed's tsunami of liquidity is driving up tech shares but it's the most speculative part of the market which is being bid up the most.

Earlier this week, I noted on LinkedIn that both the S&P Biotech ETF and the Nasdaq Biotech Index made new record highs:

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And if you look at the top-performing stocks over the last month, you'll see a laundry list of small biotech stocks with which you're most likely unfamiliar:

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And this is just a partial list. The top 250 performers are replete with biotech names.

Many of these stocks are up over 100%, 200% or 300% over the past month on nothing more than hope and hype.

This is especially true of stocks of biotech companies investors are betting on will find a vaccine for COVID-19, like Moderna or Novavax:

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Now, I've been trading biotech long enough to know a few things:

  • These stocks swing like crazy. Even the biotech ETFs swing like crazy
  • If you play individual names, you can get stinking rich but most people get their head handed to them
  • The sector does well when the Fed is on the sidelines and cranking up its balance sheet, like now

Momentum traders and quant funds will tell you to "buy the breakout in biotech" but right now short sellers are all over it:

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So, either the shorts will get scorched shorting biotech, or biotech will get creamed as fundamentals take over the hype or momentum traders book their profits.

I don't know but either way, it's a very risky trade and it's emblematic of a very sick market which reminds me a lot of 1999 when tech stocks were going parabolic for no real reason except ample liquidity.

And it's not just biotechs. Check out shares of NVIDIA Corporation, up another 6% today and making a new record high:

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Hedge funds love this stock, it's their go-to powerhouse momentum tech stock, and they simply can't get enough of it, buying every dip. Hell, I know brokers who love this stock and arrogantly peddle it to me like it's a no-lose proposition.

The point I'm making is the Fed is fueling another bubble in certain speculative stocks and it won't end well.

Yes, Wall Street loves it. BlackRock loves it. Elite hedge funds love it. But it's another bubble forming and it won't end well.

Anyone who tells you "just buy momentum stocks and close your eyes" in these markets is a fool:

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The problem is the Fed is messing with markets so much that even smart strategists don't know where it's heading:

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But I would listen closely to top investors who are not blinded by what is going on:

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Of course, all eyes will be on this man come Sunday evening:

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Jerome Powell is being praised for his "decisive and swift actions" but truth be told, he's petrified about what will happen if the market starts shorting the Fed and other central banks, something we haven't seen before.

Right now, the Fed is doing exactly what the market wants, inflating its balance sheet up the wazoo to support the BlackRocks, Vanguards and Fidelitys of this world as well as elite hedge funds which frontrun the Fed, but what happens if investors start losing confidence in the Fed itself?

I'm not saying it's going to happen, but beware of market risks. They're actually a lot higher now than in March, and investors who are blindly buying the "Fed put" playing momentum stocks as if they're invincible are in for a very nasty surprise.

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On that note, it's a long weekend in Canada, so I'll be back on Tuesday.

I want to thank all of you who value the work that goes into this blog and who support it with your donations/ subscriptions at PensionPulse.blogspot.com. Have a great weekend!

Below, one of the greatest investors of our time, Stanley Druckenmiller, Chairman & CEO, Duquesne Family Office LLC, discusses today's market strategies with the moderator Scott Bessent. Bloomberg’s Dani Burger also reports on “Bloomberg Daybreak: Europe.”

And CNBC’s “Halftime Report” team is joined by David Tepper of Appaloosa Management to discuss his investment strategies amid the coronavirus pandemic. Listen to what he says about the "franzy" going on in individual names and even if he's not short, he says the risk-reward isn't good.

Leo Kolivakis is a Canadian-based senior analyst specializing in pension funds and investments across public/private markets.

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Equities Contributor: Leo Kolivakis

Source: Equities News

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