How Much is Enough?
After a big month, do we need a break?
The big tension right now seems to be the worry that stocks can’t possibly go higher after spending the last month going up 10%. No doubt, that’s a reasonable fear. Among other reasons why the fear seems justified, the Iran war hasn’t been resolved, hedging has been greatly reduced, and the rally has been very narrow.
Again, that’s reasonable, but nothing ‘has’ to happen. If anything, it’s often the reverse. For instance, we spent the last month or so getting more constructive in large part because the market was heavily hedged for downside despite reality failing to catch up with initial fears. Now, all the upside revulsion primarily tells you many aren’t positioned for continued gains. That contrarian mindset certainly isn’t easy, but that’s how you can make gains-- taking advantage of uncomfortable pricing discrepancies.
While I recognize there are risks, I continue to think more upside is likely for several reasons. To me, the basic worry markets have is that the Iran war is spiking oil prices which in turn is making markets believe inflation risk is rising. This effectively makes markets discount future dollars, meaning future earnings are worth less. Thus, growth companies who get a lot of earnings in distant years should do poorly.
This hasn’t really happened, though. Admittedly, semiconductor companies who have both present and future strong prospects have some of the best performance, but other AI related names who currently have poor present earnings have also done fine. Those strong growth prospects are outdoing inflation fears.
How can you see that strong growth outlook? I’d say largely through the bond market. Corporate bond sales and demand have remained very strong. Both primary and secondary markets are seeing year-over-year growth. A lot of bonds are entering the market, many AI-associated, and the appetite for them has been strong. Specifically, Y/Y issuance has been up 16% Y/Y, as of the end of March. That means credit growth has been strong, to support companies and the economy.
High yield credit spreads did get hit for a bit there, amidst the combo of inflation risk and private credit fears. However, we’ve also recovered from those stressed levels and have returned to a stronger trend. We were somewhat stressed in March but relaxed quite a bit in April. Payment risk fear is getting lower, meaning investors are OK with getting more aggressive.
The economy has also held up surprisingly well. The latest Atlanta Fed GDPNow estimate for Q2 is 3.5%, on the basis of a strong start for the quarter’s data, while the more staid NY Fed GDPNow is at a still respectable 2.52%. You can talk about fears of a slowdown, but it doesn’t seem like one has yet started.
Again, to me the primary fear is that the Iran war creates real trouble. That said, the market seems relatively unperturbed. Oil volatility hasn’t come close to March highs, while oil has been hard-pressed to trend upward for long. As I write this, active talk of more deal negotiations is getting some excited.
If we can put the Iran fear to bed, there’s a lot going for markets. Broad market earnings have been strong, AI growth gives us something to be excited about, and liquidity and positioning have room to get even better. Potentially, we can go up quite a bit in a short period of time, which is probably a big part of why the market has a hard time going down.
Ultimately, the bond market, growth, and liquidity all say everything looks good and can get even better. This can absolutely go wrong but nothing yet has triggered a good cause to worry. I understand it’s uncomfortable to be aggressively long, here, but that’s why the upside potential still looks so good. Being uncomfortably long has been the right call in the last month, and while the environment now is different, I don’t yet see a trigger to change that stance.