Did the Journal just call the Top?

Sean RingSean Ring

Editor, Rude Awakening

 

Dear Reader,

Happy Monday! I hope you enjoyed a restful, rejuvenating, and reinvigorating weekend. I’m going to ease you in this brand new week with lots of easy-to-read pictures and perhaps even a feel-good conclusion to today’s Rude. I like to spoil you.

But first, let’s dispense with the usual craziness in today’s markets.

Did the Journal really just call the Top?

I despair for the retail investment crowd. Wall St and Washington have teamed up to bully, browbeat, and shove them into a stock market they scarcely understand. And when they finally relent and invest, it’s time for a correction, or worse, a crash.

Have a look at this chart from The Wall Street Journal that shows how much equity U.S. households own as a percentage of their total financial assets.

Stock allocation

What concerns me about the above chart is this: not long after the local peaks, we have some sort of calamity. After the late 1960s peak, we had the 1970s bear market. After the 2000 peak, the Nasdaq crashed. And after the 2007 peak, we had Lehman and the Crisis of 2008. Now U.S. households have never held more stock.

A trend follower would be pleased as punch. A contrarian would be looking for the exits.

Is cold, hard cash propping up the market, at least?

FINRA is kind enough to report monthly margin statistics on their website. Margin is the amount of money an investor borrows to purchase stocks. His broker lends him this money. Of course, the investor must pay this money back at some point.

The investor hopes it’s after a chunky gain and not because he receives the dreaded “margin call.” A margin call happens when the investor’s stock position is losing, and the broker wants his money back before the investor loses any more.

Mark Twain was indeed correct when he said, “A banker is a fellow who lends you his umbrella when the sun is shining but wants it back the minute it begins to rain.”

But in and of itself, margin debt isn’t a bad thing. The judicious use of margin can add multiples to your return, but you must be correct on your trade idea to begin with. Our friend Robert Kiyosaki talks about this all the time with real estate debt. The same principle applies to the stock market. Also, the interest charged on margin, small though it may be, is an additional source of revenue for brokers.

What furrows my brow is that margin debt is at an all-time high. In the chart below, you can see, Nasdaq crash and the 2008 crisis notwithstanding, margin debt has fairly steadily grown over the past 24 years. But since its low point in March 2020, margin debt has increased nearly 72%.

Also, the 822,551 on the chart, its current standing, is in millions of dollars. That means the total amount of margin debt outstanding, of money owed by investors to their brokers, is $822,551,000,000. That’s nearly $1 trillion or 3% of the current US GDP.

The hope is that the returns from the stocks owned will pay for that margin debt. Thought and prayers, my friends. Thoughts and prayers.

Debit Balances in customer securities graph

Robinhood Corroborates…

What’s sucking more and more retail investors into the stock market are free commissions. The Payment For Order Flow (PFOF) model has allowed brokers to charge investors nothing to trade, but it’s enriched them nonetheless. But how?

The PFOF model works like this: you put in an order to buy, say, 100 shares of TSLA. Your broker then directs your trade to a market maker to execute. That market maker pays your broker for directing the trade their way.

Allegedly, the benefit to you is that the competition to fill your order drives down the cost of trading, which can be in the form of tightening the bid-offer spread of the stock you wish to buy. Everyone is supposed to benefit.

The jury is out on how much retail investors make out, but it’s crystal clear how much the brokers do. According to the Journal, Robinhood generated PFOF revenue of $331 million in the first quarter of 2021. As Robinhood made $690 million in PFOF revenue for the whole of 2020, this is a considerable increase. But they’re not the only ones making coin off this. Have a look at this chart:

Payment for order flow revenue in 2020 by brokerage

No need to remind you that if a service is free, you’re the product.

Again, there’s nothing inherently wrong with PFOF, as long as retail investors don’t get screwed. But it makes hitting the buy and sell buttons much easier when you’re not paying $10 for the pleasure.

And finally, the youngsters may also give a clue as to what’s happening.

TikTok – Time May Be Running Out For Some

Nassim Taleb, the Renaissance Man of Our Day, once wrote on Twitter, “It takes five years to learn how to make money; and twenty-five to learn how to not lose it.”

I hate that he’s almost always right.

(By the way, if you haven’t read Fooled by Randomness, Black Swan, Antifragile, and Skin in the Game, put them on your reading list!)

Knowing this from experience, I cannot for the life of me figure out why any 25-year-old would want financial advice from another 25-year-old. It’s insanity.

Sure, I wouldn’t mind asking a 25-year-old Mark Zuckerberg how to build a social network—or asking a 25-year-old Bill Gates how to write code. Or asking a 25-year-old Matt Damon, who had dropped out of Harvard to pursue acting and had written the Good Will Hunting screenplay with best bud Ben Affleck by that point, how he was so sure of himself he decided to forego his remaining three years at Harvard.

Damon, by the way, took a far bigger risk dropping out than two rich kids like Zuck and Bill.

But, “How do you make money?” Not from a 25-year-old. Ever. If they’re rich by then, they’ve got some other skill that made them rich. Sports. Entertainment. Media. Not investing. Even in crypto.

And even if they made a ton, they haven’t had enough time to lose it and then make it back again, as nearly every self-made millionaire I know has.

But that hasn’t stopped today’s whippersnappers from seeking financial advice from – get this – TikTok. Yes, the same app where bored nurses go dancing. The same app where you can learn the latest taco recipe.

One person, in particular, seems to like other young people who “don’t come across as judgmental or preachy about what she should be doing with her money.”

Forgive them, Lord! They know not what they do!

But Sean, You Promised Me a Feel-Good Conclusion!

So I did. And now it’s time to deliver it.

It’s the first business day of May, and that means monthly charts are in.

Now the news cycle is terrible. A bit ridiculous if you ask me. But do the charts corroborate their stories?

I mentioned the “Everything Rally” in my lead. That’s the name analysts have given this rally because everything – stocks, bonds, commodities, real estate – was going up. While I don’t think that’s the case anymore, some stuff is still definitely going up.

I’ve made the charts as easy to read as I could’ve. Red means down. Green means up.

First, let’s look at the overall market via the S&P 500:

Overall market Via S&P 500

The S&P 500 is above both its 50-day moving average and the 200-day moving average. (That’s just taking the average close of the last 50 or 200 days and rolling it along. We do this to smooth out the movements.) When the index is above both of these, we can safely be bullish.

The following chart shows the monthly S&P500 and its 9-month moving average. As there are on average 22 trading days in a month, 22 x 9 = 198 days. That’s close enough to a 200-day moving average for me.

S&P 500 9 month moving average

Notice that before the 2000 Nasdaq crash and the 2008 financial crisis, we had a few months warning – trading under the 200-day moving average – before the market went to hell. Those are the blue boxes.

Now, look at the far right of the chart, where we are now. We’re nowhere near any sort of panic level. This is positive for the stock market.

For commodities, I cherrypicked a few screamers. First up is copper. Copper is the most important base metal and often a leading economic indicator. That’s why commentators occasionally refer to it as “Dr. Copper.” We need copper for everything we build, whether it’s office towers, airports, terminals, or roads. It’s up 2x since March 2020.

Copper Chart

Next up is the dizzying rise of lumber, up over 3x since March 2020.

Lumber Chart

Might want to hold off building that new deck.

As seen on Facebook:

Lumber

Next up: oil. After last year’s Russia-Saudi standoff, which drove oil into negative territory, we’ve seen a furious rebound as well. It doesn’t look like much on the chart, but we may be heading to $80 per barrel soon.

Oil

So commodities look pretty bullish to me.

But bonds? Government bonds look ugly. Here’s the TLT long bond ETF:

TLT Chart

But the HYG junk bond ETF looks fine. That’s probably because junk bonds tend to act like equities because of their credit component. While investment-grade bonds’ main driver is rate levels, junk bonds are far more sensitive to things like the cash flow of the underlying company.

Here’s the HYG chart:

Hyg Chart

And finally, property. According to Redfin, the median U.S. house price rose 20% year on year. That doesn’t look like a bear market to me.

To wrap this up, the only asset class that doesn’t look like it’s worth owning right now is government bonds. It makes sense, as the rates that drive government bond prices are sensitive to inflation. The same inflation that drives asset prices up scares bond investors.

So the good news is this: the news is trying to anticipate a downturn in the stock market that simply hasn’t happened yet. And there’s no evidence in the charts that it’s going to happen any time soon.

But we must always stay vigilant.

And with that bit of good news, I wish you a happy Monday and a great week ahead.

All the best,

Sean Ring

Sean Ring
Editor, Rude Awakening

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