December 4, 2024 | When is the US stock market going to correct? That is the question we hear increasingly from readers of The Institutional Risk Analyst. Many of the major indices are up mid-double digits so far this year. Notice that the large-cap financials have led the way, as we have predicted in our Premium Service, and the WGA Bank Top Indices confirm this trend. Does anybody think that large cap US banks deserve to be up 40% YTD?
Source: Google Finance
President elect Donald Trump has not even taken the oath of office, but a number of stocks and crypto tokens have soared since his win in November. PSQ Holdings, Inc. (PSQH), “America's leading commerce and payments ecosystem valuing life, family, and liberty,” announced Donald Trump Jr. and Willie Langston joined its board of directors, causing the stock to surge a little. PSQH is still down almost 50% from the 2023 IPO, but no matter. How's that for a chart?
Source: Google Finance
One of the more amusing aspects of the post-election process is the idea that President Trump and his family will be helpful to the crypto sector. In fact, Trump will be helpful to his crypto token. Remember, its all about the Donald. Meanwhile, Alex Mashinsky, co-founder of crypto lender Celsius Network, pled guilty yesterday in New York to two counts of fraud for artificially manipulating the value of his token.
As we get further and further from the manic years of 2020 and 2021, the volatility of many stocks have fallen significantly in dollar terms, but the percentage gains from the persistent episodes of euphoria are impressive. In financials, for example, the Trump Trade has caused the undead to not just walk, but run. We view the multiple all time highs for major stock indices this year as a sign than a significant blowoff is coming in global equities, a correction ultimately driven by the ebb and flow of inflation.
Witness penny stocks like Freddie Mac and Fannie Mae up more than 100% in the past 30 days. Remember, it’s a trade, not a destination. As we noted in our previous post ("Kamikaze GSE Release?"), the odds of actual release of the GSE by the Trump Administration are less than 1 in 5. As Moody's Analytics chief economist Mark Zandi told an audience in New York City last night, GSE release is a solution looking for a problem since nobody in the mortgage sector supports the idea.
Our best guess is that GSE release will push up conventional mortgage spreads by 50bp meaning a 7.5% mortgage coupon given TBAs this morning. And that is before we deal with an impending downgrade of the US, as discussed below. Once it becomes clear that the White House does not have the time or political capital to push through a GSE release from conservatorship, we suspect that windfall gains will evaporate. Don’t be that greater fool. Freddie Mac peaked at $3.50 on 11/26/24 and has since given back a $1 per share.
Source: Google Finance
Another remarkable story is SOFI Technology (SOFI), a languid fintech/bank name that has underperformed the market for several years, but began to rise in August and then exploded on October 1st. SOFI more than doubled since that time. SOFI was up 44% in the past month and 112% over the last 90 days. What happened?
The SOFI financials in Q3 2024 were OK, but the Street apparently liked the growth in customers. SOFI is a small consumer lender that still needs to grow significantly to fit into its bloated overhead costs, which are more than 2x Peer Group 1. SOFI also continues to see large volatility in its financials. Lacking a tangible catalyst, we would not be surprised to see SOFI give back recent gains.
In the world of fintech, the top performer in our surveillance list is Lemonade (LMND), a provider of insurance products through various channels in the United States, Europe, and the United Kingdom. Good news: LMND is losing less money than in previous years, but it is still losing money. Equity managers simply love it.
The stock is up 180% YTD and particularly in the past month. It began to move in mid-October below $20 and took off at the start of October. The stock peaked at $53.85 on November 25th and has given ground since then and closed at $45 yesterday.
Another member of the Trump Trade group is Robinhood Markets (HOOD), a high-flying broker dealer that went public in 2021 at the end of QE, ran up to $85 in August 2021, then collapsed below $7 in June of 2022. The business model remains retail brokerage + crypto, which should tell most investors all they need to know. In August of this year, HOOD began to climb the stairway to heaven and reached $38 at the end of November.
Source: Google Finance
HOOD is up more than 200% YTD. Given that the US economy is growing 3-4% per year with a $2 trillion budget deficit, some economists would say that the economy is performing "better than expected." Our view is that the behavior of financial markets suggests that inflation remains a serious problem, but equity managers are loading up on market risk to an astounding degree.
One event on the horizon that has not yet gotten nearly enough attention from the thundering herd is that Moody's Investors is now the only major rating agency that still has the US at a "AAA" rating. When the US sovereign rating is eventually downgraded, everything that depends upon the US rating, including federal agencies, large banks, Ginnie Mae and the GSEs will also be downgraded.
The US is trading around 30bp in 5-year credit default swaps (CDS), a spread that suggests a "A/BBB" rating for the US using the classic S&P ratings breakpoints. As we've noted in The Institutional Risk Analyst many times, the average US consumer is around a "B/CCC" credit, which is why credit card rates are well above 20%. Sabe?
AAA: 1 bp
AA: 4 bp
A: 12 bp
BBB: 50 bp
BB: 300 bp
B: 1,100 bp
CCC: 2,800 bp
Default: 10,000 bp
How will equity managers react to a credit downgrade of the US by Moody's to "AA+" in the near future? We suspect that they will huddle during the commercial break, become comfortable, and then buy more US equities. We can all look forward to the day when many large corporate credits will be trading inside the credit spread for the US. But what happens to the Trump Trade and the broader equity markets if the FOMC passes on a December rate cut?
Federal Reserve Bank of St. Louis President Alberto Musalem said it may be time for policymakers to slow the pace of interest-rate cuts amid higher than desired inflation and declining concerns over the labor market, Bloomberg reports. Musalem says that it will likely be appropriate to keep lowering rates over time, but said the risks of cutting rates too quickly are greater than those of easing too little.
“It seems important to maintain policy optionality, and the time may be approaching to consider slowing the pace of interest rate reductions, or pausing, to carefully assess the current economic environment, incoming information and evolving outlook,” Musalem said in remarks prepared for the Bloomberg & Global Interdependence Center Symposium in New York.
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