KSS

Two Good Reasons to Worry About Stocks

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I am, against my better instincts, getting worried. Logic tells me that even with the frequent new highs, this rally is based on economic fundamentals and low interest rates, and is therefore sustainable, but I can’t escape the feeling that at some point it has to turn. Most of the time it is just that, a feeling, and there is no real reason to feel that way.

Right now, however, there are two specific things that have me worried.

The first is that there has been a tendency to overreact to good news and underreact to bad news this earnings season. Earnings reports have generally been good, which should put my mind at rest, but then I look at something like Roku (ROKU) and the worrying starts.

I should say at the outset that I think ROKU is a great stock to own, and said just that shortly after the IPO. That recommendation makes me pleased to see the stock at these levels, but when a stock jumps over 150% on a smaller than expected loss, alarm bells about the market as a whole start to go off in my head.

I still like the stock long-term, but my logical side is screaming “Too far, too soon!” A three-day move like that is more about traders and institutional investors feeling starved of opportunity than it is about Roku’s very real prospects and performance, and that is a worrying thing.

As I pointed out last week, even stocks in the structurally challenged retail sector jumped on “not as bad as it could have been” earnings reports. That tendency to buy aggressively on any good news leads to overly optimistic growth assumptions, and valuations that put pressure on companies to try and make those assumptions come true at all costs.

It is not just buying on good news either, this market is also doing its best to ignore the bad. Sticking with retail, Kohls (KSS) missed earnings badly, but recovered all the losses immediately, and by the next day was trading significantly higher than pre-earnings levels. I hesitate to throw around the “b” word, but too much money chasing positive news and ignoring negative stories is the definition of froth in the very least.

If nothing else, it signals a strong appetite for risk in the stock market. That is not a bad thing usually, but when other markets are signaling the opposite it can be a warning sign, and the extremely risk-sensitive high yield or junk bond market is doing just that right now.

The chart below is for the high-yield ETF JNK and strongly suggests that not every market is as confident as stock traders about the outlook for risk assets.

The dollar is also edging up and bond yields are staying noticeably low given the knowledge that rate hikes are coming, and as the Fed begins unwinding its massive bond portfolio. It is possible to find reasons for a strong dollar and bond buying that are market specific in some way, but even so, those trends hardly suggest massive confidence in international markets regarding the U.S. and global economies.

In general, I try not to worry about the stock market. Of course, there are always plenty of things that could cause you concern, but most are not rational. If something in the news has you worried, for example, you should remember that its very presence in news stories means two things.

Firstly, it means that the event is in the past. Secondly, things that happen frequently don’t merit news coverage, so whatever happened, it was an unusual, notable thing. What has you worried is therefore a rarity that has just occurred, which makes it extremely unlikely to happen again soon. Logically, therefore it is not worth worrying about, especially as the market’s default direction over time is up.

There are times, though, when analysis designed to put your mind to rest actually increases your anxiety level, and this is one. The optimism in the market seems to have moved from perfectly justifiable to somewhat irrational if you look at the reaction to earnings in individual stocks, whether those earnings recorded a beat or a miss. In addition, high yield, the dollar and Treasury yields are at best neutral, which suggests that the stock market’s view is the one out of line.

Those two things make it hard to stay positive, no matter how hard I try, and are real reasons to worry right now.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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