Rates are all the rage these days. The Fed, backed by their unlimited digital printing press, promised us rock bottom interest rates into 2022. The $14 Trillion US Treasury Bond market however has become the Reddit bane of the Feds existence by selling Bonds, forcing yields higher much earlier than the Fed prefers while Covid induced unemployment remains elevated (6.3%). Bond traders are certain that inflation will keep rising and possibly explode upwards when pent up consumption is unfurled on a fully open economy later this year. The stock market can continue in a Bull market higher just fine in tandem with rising interest rates. What makes investors nervous is when rates rise too quickly or too far. Most forecasters had 1.5% as the year end “high” for the 10 Year Treasury yield. When rates jumped past 1.2% two weeks ago, equity investors became nervous. When yields popped above the key 1.6% level, a brief scare infected stocks this week. If rates can consolidate under 1.5% and edge slowly higher, stocks can resume their run to record highs as they await the next stimulus passage in March. Any surge over 1.65% opens up the worry wagon for a quick trip to the 2% level in March while the economy remains partially closed.

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Interest rates may be the new wall of worry, but our readers have inquired how stocks can be so detached from earnings and sales this past year? Stocks were hitting record highs in early 2020 before the pandemic partially shut down the global economy. Understandably, SP 500 Index earnings fell a whopping 15%, 32%, and 8% respectively during the first 3 quarters of 2020 and a hefty 15% contraction for the year. Yet the stock market (SP 500 Index) recovered from a 30% loss to post an 18% gain for 2020. The rational reason that revenue-deprived stocks have run so far so fast without a serious correction is that the markets are a discounting mechanism and have been continually revising growth and profit expectations higher since the market nadir 11 months ago. With record GDP growth of 5 to 7% now expected in 2021, far above the 2% norm, it’s estimated that overall corporate earnings will not only recover their huge losses of 2020 but surge easily to new highs of 25% above 2020 levels and 7% higher than the record 2019 peak. The market does seem frothy with many stocks being richly valued years before sales can even begin. However, at 21 times expected 2021 SP earnings, stocks may not be so extreme in the aggregate. The other reason stocks in many sectors can keep running to record heights despite massive losses and unknown future sales is TINA (There Is No Alternative). With our Federal Reserve and Central banks around the globe having forced interest rates (borrowing costs) to record lows along with a tidal wave of Government handouts, there is tremendous excess liquidity that ends up in the stock market at premium prices. Furthermore, investors feel confident that monetary and fiscal policies are firmly entrenched that will prevent a renewed panic and provide a secure financial bridge taking us to the other side of a fully open Covid proof economy. As we have shared before, individual balance sheets are in good shape with record low cost of debt service relative to income as well as above normal personal savings while we await even more massive stimulus bills that will arrive soon. Consumer savings rates are back over 20% in January with almost $3 Trillion in excess personal reserves that will certainly rise when the March stimulus is passed. Then there is another infrastructure stimulus that stocks will begin pricing in after the March passage, which could kick equities back above what may seem like nose bleed levels. With a consumer savings rate of 20 to 30% that will certainly fall back to the 7% norm again, we know there will be a flood of spending on the service economy once the cowering from Covid ends.

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While the past 11+ month SP stock surge of “86%” from the pandemic trough can be justified as outlined above, it doesn’t mean that a similar surge is ahead or that larger and longer corrections have been banned. We identified last November that our main upside target potential was the mid 3900’s basis the S&P 500 Index with the updated chart below. Our mid-point target ofSP 3848 was reached in January and caused a modest 5% pullback over a few days. Our main projection near 3950 was hit last week and thus far has triggered a 4% drop over 8 days. With the current Bullish monetary and fiscal backdrop continuing at least into the Q2 economic reopening period, there is potential for this mild equity correction to reach 7% (upper 3600’s in SP). If the Fed pushes the 10 Yr back under 1.45%, then the current SP pullback of 4% may be sufficient to send stocks back to their recent record highs. Our pullback time and price window and other support levels for renewed buying are shown below.

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Speculative trader optimism has kept overly Bullish Call option purchases at elevated levels since the election, but this will change later this year as forward earning expectations peak. Our forecast continues to be that the extremely low volatility and shallow market correction phase since last March will reverse in 2021 leading to scarier market corrections by May/June. Investor expectations of more fiscal and monetary stimulus will vanish in a few months, replaced by the evolving concern of higher credit costs, taxes, and a future slowdown in 2022 consumption. Our option sentiment metric should return to the oversold Buy zone by the end of Q2, but for now, excess liquidity will remain anxious to “buy the dips”.