Wednesday's Market Minute: Markets Look Primed For A One-Two Punch

There are two headwinds developing against investors right now. One is froth building up in stocks that increases the odds of correction. After getting trampled by squeezes the last two weeks, the median short interest on stocks in the S&P 500 Index is now 1.6% of shares, an all-time low that is only matched by the dot-com era level of 1.5%, according to Goldman analysts. That's wild.

If there’s been one thing to count on throughout the ups and downs of the stock market the past decade, it’s that there was always someone betting against it. Now that cohort has all but vanished. It’s truly an incredible thing when you consider that short investors are the buyers of last resort in bear markets where everyone else is selling. Without them, investors are driving on a highway without guardrails.

That’s the first risk. The second will be a familiar refrain for subscribers of this newsletter. It's bonds. The stock market may look unstable, but the economy does not. While economists and data wonks are still lost in the cracks of the employment situation, they miss the forest for the trees: Americans are richer than they were pre-COVID, and are chomping at the bit to spend in the real economy. COVID curves are plunging in the most exciting way possible and vaccinations are hitting a steady pace. Who knows what stimulus plan policymakers in Washington will agree on, but it won’t be nothing.

So bond yields keep on climbing, no matter how dovish Powell gets. That makes sense: the more he promises not to hike, the more certain we can be that inflation will at some point get hot, and therefore the more likely bonds will go down in value. Yields have been resolute in their march higher since August. When price trends are as obvious as this one, it's only a matter of time before traders will exploit it. That means potential for yield shocks.

I'm not sure in which order this one-two punch makes the most sense. One could easily envision the stock market extending its rally thanks to bond money that gets put to work in equities once the economy reopens. But, it's also easy to see to see how a much-needed equity correction could send investors back into bonds, effectively coiling the spring for yields to rip even quicker when the economy does pick up steam.

Photo by Uwe Conrad on Unsplash