Swissquote Bank: Bulls under Joe

Swissquote Bank: Bulls under Joe

Equity
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by Ipek Ozkardeskaya, Senior Analyst at Swissquote Bank

The week started on a positive note for equities after a gloomy close on Friday, as investors pushed aside the worries that the new strain of coronavirus which is about 70% more contagious than the previous one could also be deadlier, and the fact that there are important delays in vaccine distribution. The attention shifted back to Joe Biden’s extra $1.9 trillion stimulus package which should provide more relief to the US economy and to households, that there is certainly more stimulus on the way and that the Federal Reserve (Fed), which will meet this week, will continue its $120 billion worth bond purchases each month. 

Gold bears are applying a strong downside pressure on the 200-day moving average near $1846 per ounce, as the risk appetite remains solid despite all the negative vibes due to the virus, and the US 10-year yield holds near the 1.10% mark.

With Biden taking the reins, one would have expected at least some negative reaction from equity traders as Democrats would concentrate on redistribution of wealth, and social rights and benefits - which are all negative for company earnings, but the data tells a different story. Over the past three decades, the S&P500 stocks gained more under the Democratic presidents than the Republicans, including Donald Trump.

So, the idea that a Democratic president would kill the markets is not well founded and we have seen the S&P500 easily carrying on its record run before and after the election. From what we observe, there is little to stop the stock bulls from racing even under Joe Biden - and especially under Joe Biden because this time the setting is also completely different. The US, as the rest of the world, is struggling with the Covid-led health and economic crisis. There is only one direction that any governor would take : throw more money on the economy.

So, all this is extremely promising for an average stock investor even though Janet Yellen saw strong Republican resistance during her confirmation hearing in the Senate last week. That means that the package may not hit the street too soon, but it will at some point. And even if it doesn’t, the Fed will continue giving the necessary support to keep the bulls running.

Speaking of the Fed, the Fed will likely reiterate its dovish stance at its monetary policy meeting this week, as the Covid crisis gains traction across the world, even though, the massive fiscal aid packages should at some point boost the inflation expectations, the inflation, and interfere with the Fed’s capacity to bring more cheap liquidity on the table. But let’s not worry about the inflation just yet – we are nowhere near hitting the Fed’s average target of 2% for now.

With all this, the S&P500 finds solid support near the 3800 mark as investors can simply not have enough of the historical market rally. No one wants to jump off of the back of a running bull. So, the despite the skyrocketing blue-chip prices, any downside correction to the big US stock indices will likely be seen as interesting dip buying opportunities by investors.  

This week, big names including Apple, Microsoft, Tesla and Facebook will release earnings. Most of these companies’ businesses were boosted by the global shift to the pandemic way of life, therefore the rise in their prices is not surprising per se. Still at the current prices, it is clear that investors praised these companies beyond reason, so we may still see some profit taking despite strong results.

Microsoft and Facebook’s last twelve-month PE ratios are 36 and 30, meaning that they trade more than 30 times their earnings. Apple’s PE ratio is 40 and Tesla’s is just above 1500. Looking at these values, stimulus or not, it is impossible that the actual trend continues for long. But we also know that a downside correction, if any and no matter how strong, will only be followed by a jump thanks to the endless promises of more stimuli. 

There is one more thing that supports the idea of higher stock prices: the rise in call options demand in equities, indices and ETFs during the course of last year show that investors, from small to institutional size, didn’t wait for dips to happen before buying, they just piled into the call options, buying the right but not the obligation to buy these assets at a predetermined price and a predetermined date, to make sure that they are not left behind this crazy market race.

One direct implication of the rush to these call options is that the sellers of these options hedge their positions by buying the underlying stocks, which in turn, gives further support to their prices. So, it’s just like a chicken and egg story.

I totally reckon, it’s simply impossible to feel comfortable with such rapid price jumps, and naturally a correction at these levels should only be healthy. But in the medium term, there is no apparent reason to force the bulls to the sidelines, even and especially under Joe Biden. Of course, all reward comes with its own risks. Given the level of inflation in these stock indices, the risk of having a severe pullback is real. But it seems that the dip buyers will continue providing a solid safety net to the major US indices in the foreseeable future.