The State of the Market: Executive Summary

From my perch, there are three factors driving stock prices to-and-fro these days. First, there is the state of the on-again-off-again stimulus talks, which appear to be a modest positive again this morning. Next, there is the state of the coronavirus pandemic, which is clearly not going in the right direction here. And finally, there is the rise in interest rates, which is starting to gain the attention of traders.

On the virus front, the good news is that vaccines appear to be coming - and soon. We should learn the stage 3 trial results of at least two potential vaccines in the coming weeks. At this point in the game, traders, and in turn, the markets, are betting on a positive outcome. And as I've opined previously, this allows investors to look ahead to better days - to a time when some semblance of pre-COVID "normality" can resume.

The bad news is the number of cases is surging again - almost everywhere. My take is that the combination of schools opening and cooler weather forcing people to gather indoors again is causing a resurgence in the spread of the virus. But it is encouraging to note that there are better treatments eight months into this thing and according to the data I review each day from Johns Hopkins, the death rate is clearly slowing.

On the interest rate front, don't look now, but the yield on the 10-year has been rising - reaching the highest level since June on this fine Friday. I consulted my personal "bond kings" at Northern Capital on the subject yesterday afternoon. The firm's Chief Investment Officer, Mr. Stephen Rye, said there were two primary drivers of the move up in rates: New supply and the Biden tax plan.

As we've discussed, Wall Street appears to be discounting a Biden win. The good news for the market is this is expected to bring a larger stimulus package. This is a good thing for economic growth. However, it is a bad thing for the supply of government bonds. You see, despite being the largest, most liquid market in the world, there is still a limit as to how much debt a country can issue in a short period of time. Thus, it looks like bond buyers have been starting to demand a bit more yield from their purchases.

Then there is the tax aspect of the situation. Mr. Rye opined that, while increasing taxes isn't great for equities in the long run (an opinion seconded by Paul Tudor Jones yesterday), it is a very strong development for municipal bonds. In short, with taxes going up for the rich, the demand for tax-free havens is likely to increase.

This is to say nothing of the potential for inflation. Yes, I see that there are inflation pressures building as a result of the coronavirus. But from a big-picture standpoint, I just don't see a meaningful increase in inflation - largely due to the current levels of unemployment, which remain massive from an historical perspective.

My thinking is it will take quite some time for the economy to work through the unemployment problem. And until the country can return to full employment, we probably don't need to fret about runaway inflation. Now let's check in on our Fundamental Factors indicator board.

The State of the Fundamental Models

Ditto from last week, as there are no changes to the Fundamental Factors board again this week. My take is that monetary conditions remain positive and supportive of both the economy and the stock market, the economic composite continues to show improvement, earnings are starting to show signs of life (both GAAP and Operating EPS estimates look to have bottomed and are now starting to move higher), inflation is not much of a problem, and valuations remain at extremely high levels.

However, as I've mentioned a time or two lately, we know that valuations tend to spike when the economy emerges from a recession. So, all in all, my view is that the board continues to favor the bulls from a big-picture standpoint.

* Source: Ned Davis Research (NDR) as of the date of publication. Historical returns are hypothetical average annual performances calculated by NDR. Past performances do not guarantee future results or profitability - Not individual investment advice.