The media and stock market analysts are all aflutter today following the stock market’s dramatic rebound.
Thirty minutes after today’s open, the Dow cratered 300 points in a matter of minutes, only then claw its way back and finish up 122 points.
The stock market has been caught in a trading range for a number of months, as news oscillates between bullish and bearish. On the one hand, the market is jittery about the ongoing trade war with China, the cratering of the manufacturing index, and the threat of presidential impeachment.
On the other hand, corporate earnings are holding up, the economy is at near full employment, and a number of companies hold near record levels of cash.
So what drove the stock market back from the brink today?
The media is pressing its case that another Fed rate cut is coming. Indeed, the latest analysis seems to suggest a 90% chance of a 25 basis point rate cut at the Fed’s next meeting.
Don’t be so quick to buy into that.
While stock market prices ultimately follow the long-term trend of corporate earnings, the stock market is also at one of its most expensive levels in modern history, as you can see from the chart below:
The market has thus priced in even the most optimistic of scenarios going forward several years. That alone doesn’t necessarily indicate a crash is right around the corner.
Yet we can never look at anything in a vacuum.
Investors often forget that the stock market indices are primarily controlled by a small number of very large companies.
Ed Butowsky, Managing Partner at Chapwood Capital Investment Management, reminds CCN.com:
“The top 10 stocks in the S&P 500 account for 22% of the entire index’s market. Fully one-fifth of the index’s move on any given day is attributable to Microsoft, Apple, Amazon, Facebook, Berkshire Hathaway, Google (both classes), J.P. Morgan, Johnson & Johnson, and Visa”.
A savvy investor will look at that list, see a couple of companies and relax, but then become very worried for number of reasons.
Microsoft is kicking butt and taking names, is arguably undervalued, and has been entirely reinvented under new management.
Berkshire Hathaway just keeps on chugging under the stewardship of Warren Buffett. It’s about as stable a long-term investment as anyone is going to find.
Now the bad news.
Apple’s valuation is stretched. The company is growing at services business, but the iPhone still makes up a disproportionate amount of its revenue, and Tim Cook is no visionary. He’s a game manager, and for the first time in years, Apple is arguably overvalued and maybe that’s why Tim Cook is selling shares.
Amazon remains a must-own company, except it is in very real danger of being restrained by the Department of Justice’s antitrust division. It may take years for that to develop, but it creates cloud of uncertainty over the stock that has been holding it back from making new highs for months.
Facebook and Google may generate tons and tons of cash and remain the dominant advertising plays, but both are under federal scrutiny, as well.
Facebook can’t seem to get away from privacy issues, Google is not far behind, and both are facing a lot of criticism regarding alleged censorship of political views.
In addition, because both companies rely so heavily on advertising, the next recession could potentially damage both companies’ revenue streams badly.
Johnson & Johnson is a moribund company whose stock hasn’t gone anywhere in three-and-a-half years.
Visa is certainly one of the premier plays in an oligopoly that can’t be ignored, except its valuation is also through the roof.
The problem with the stock market is that investors never pay attention to risk until it’s too late.
And that, my friends, is the biggest problem in the stock market.
With everything stretched as far as it is, it will only take a few days of sustained selling for investors and institutions to hit the panic buttons.
Everyone wants to be out before the other guy.
When the crash happens, and it will happen, it will happen quickly.
Last modified: June 12, 2020 6:42 PM UTC