Another blow out week for U.S. mega-cap stocks. Of the Big 5 (Apple, Microsoft, Google, Amazon, and Facebook), all but Apple traded at all-time record highs this week (Apple remained a scant 1% below its June record high). Second-quarter earnings season for the FANG stocks is about to get started, which likely explains the disproportionate moves in Tech this week. And who can blame investors for getting into these names before they gap higher post- announcement is the coming days? Netflix is due to kick off the reporting on Monday. Google will follow the next Monday, July 23. Facebook and Amazon.com are set to release results on July 25 and July 26, respectively. We still have a hard time accepting that making money can be as easy as buying a few tech stocks prior to their earnings releases. Chances are that at least one of the FANGs will decline in response to the results. You have to go back more than three years to find the last time they all rose on the day after earnings reports — and in that instance, the stocks had all dropped in the previous quarter. So you might as well prepare now for at least one disappointment. If you want to make money in tech in the next weeks, its best to buy the QQQ.
As for macro news this past week, not much to report. CPI inflation came in as expected at +2.9% y/y, but no one cares because the Fed wants to let inflation overshoot. Ditto for PPI (+3.4% y/y in June versus +3.1% expected). Even import prices are running hot (+4.3% in June), but markets aren’t going to worry about inflation until Simon says (or rather Jay Powell says). Trump’s visit to the U.K., with his usual faux-pas, did not bother markets. Nor did Mueller’s indictment of 12 Russians for stealing emails from the Democratic National Committee and Hillary Clinton’s campaign. This market is impervious to all news.
Fed Balance Sheet – It’s Shrinking!
If news does not matter, we need to get back to our indicator charts to glean a clue as to when we’ll finally see selling in U.S. equities. The first chart that caught our eye this week was the rate of Federal Reserve bond purchases. As readers may know, the Fed stopped Quantitative Easing in October 2014, but continued to reinvest the interest payments received in the bond market. It was only in 2017 that the central bank stopping reinvesting interest on their bond portfolio. The marginal reduction in the Fed’s balance sheet from not reinvesting interest can now be seen in our chart below.
Note this in previous periods during this bull market when the Fed let up on the gas (between QE1 and QE2, then between QE2 and QE3), the S&P 500 stalled out. The same stall out on the S&P 500 has sort of occurred since January, as the blue curve of Fed bond holding began sloping down. We would be very surprised if the blue curve maintains the new downward trajectory while the red S&P 500 curve continues rising.
The Yield Curve Will Invert Over the Summer, But It Won’t Yet Matter
The U.S. Treasury yield curve has quietly continued its flattening. The 10/2 curve which we have written about frequently is now only 25 basis points from inverting (2-year yields above 10-year yields). Again, a negative yield curve has historically been a harbinger of an impending recession. Will it be so this time with all the central bank manipulation of the interest rate market? Hard to guess. But we’d predict that nervous investors watching this bubble might seize on the inversion of the yield curve to start taking profits.
Recall that an inversion of the 10/2 curve does NOT immediately correspond to an equity market top. See our report, Yields Will Signal The End Of The Bull Market (April 20, 2018) in which we show that the S&P 500 has taken as long as 19-months to top after the 10/2 curve inverts.
Conclusion
Stay in the U.S. equity game, no matter how absurd it made appear. No other equity asset class is doing a one-way ride in the up direction. However the above charts need to be monitored. More shrinking of the Fed balance sheet and an inversion of the Treasury yield curve merits moving a bit into cash or using some put option protection strategy.