Two weeks into 2021, and the S&P is flat — up just 0.5% as I write, as the market searches for direction.
Part of the challenge is the litany of unknowns before us today …
Will President-elect Biden’s inauguration go off without disruption or will there be more violence like we saw at the Capitol building?
Will Congress pass Biden’s new, proposed $1.9 stimulus package?
Will the vaccine rollout go smoothly, enabling a faster re-opening of our economy?
And specifically, for investors, will this earnings season we’re entering act as a tailwind or headwind for a market that’s priced for perfection?
In their latest Strategic Trader update, our technical experts, John Jagerson and Wade Hansen looked ahead at what’s in store for the market.
Their analysis includes the 10-year Treasury yield … slowing economic recovery data … stimulus money … the vaccine rollout … housing … and a tentative short- and long-term plan for investors.
So, what is this plan, and how are John and Wade positioning their subscribers?
That’s what we’ll get into today. I’ll let them take it from here.
Have a good weekend,
Short-Term vs. Long-Term Planning
By John Jagerson and Wade Hansen
As we mentioned in last week’s update, the 10-year yield on government bonds can give us a good idea of what the market expects from a Democratic Senate majority.
Yields can rise for a few reasons, but the most important are expectations that growth and inflation will start to rise. Now that the dust has settled from the Georgia Senate races and there is a razor-thin margin in favor of Democrats, traders seem to be pricing in short-term growth.
The 10-year yield is a benchmark for consumer interest rates on mortgages, credit cards, and student and auto loans. If investors expect more growth, then demand for capital and concerns about inflation will drive yields higher.
However, we need to be careful at this point. The 10-year has blasted through the 1% mark, which is good for banks but can be a drag on other sectors for a week or two while the market settles down.
Daily Chart of the CBOE 10-Year Treasury Note Yield Index (TNX) — Chart Source: TradingView
Assuming that more short-term growth (and therefore higher interest rates) is coming is reasonable because a Democratic majority makes additional government stimulus more likely. But as we discussed two weeks ago, any sustained growth must be accompanied by an improving employment picture.
The Bureau of Labor Statistics (BLS) non-farms payrolls report released last week showed a continued trend towards a slowing employment recovery. The Jan. 8 report showed the U.S. labor force shrunk by another 140,000 jobs. The pace of hiring must accelerate in January and February to support future gains.
While this seems like a situation where there is a balance between good (stimulus) and bad (employment) news that makes planning difficult, we can use investor behavior to navigate the next several weeks productively.
Investors tend to experience immediacy bias when making decisions about the market. That means they overemphasize short-term factors and underemphasize long-term issues. In this case, that means we can split our trading strategy into short-term actions we are taking now and a tentative long-term plan that can be deployed in a few weeks if needed.
The most pertinent short-term issues likely to affect the market are another round of stimulus and the vaccine rollout. In our view, political and economic pressures make a larger stimulus very likely in the first three months of the year.
We will remain focused on retail and tech exposure to take advantage of short-term consumer spending supported by the stimulus. We recently closed our position on Target (TGT), but we are currently holding trades in other retail firms and have a few others on our list to add as we get more opportunities.
Daily Chart of the SPDR Discretionary Retail ETF (XRT) — Chart Source: TradingView
However, as the vaccine is released, we are less likely to add too many “stay at home” stocks to the portfolio until prices for stocks like Chegg (CHGG) and Logitech (LOGI) come down a little. We still recommend making an exception for some tech superstars that have benefitted from the work-from-home trend like Microsoft (MSFT).
We also plan to add some exposure to stocks that should benefit from increased consumer and business travel. For example, we have already put Disney (DIS) back in the portfolio.
There are slim pickings in the market for a travel-related stock with good fundamentals. Still, we have our eye on an airline and another entertainment company that could give us an outsized return if the vaccine rollout looks likely to improve.
Tentative Long-term Plan
The long-term prospects for the market are a little more challenging to forecast right now. As we have mentioned several times, valuations are incredibly high, and more things can go wrong next year than must go right to sustain the kind of performance we have seen since April 2020.
In addition to the uncertainty around employment, rising interest rates could put a cap on the real estate market, which would have a far-reaching ripple effect on the rest of the market. The FHA foreclosure moratorium ends in February, and we will be watching closely to see if it will be extended. If foreclosures rise, we will not want to have any exposure to building materials or housing stocks.
The SPDR Homebuilders ETF (XHB) pictured below is a good bellwether for the housing sector’s health. For now, performance looks good, so we don’t need to make any short-term adjustments to our strategy. However, if support near $56 per share breaks, we will likely need to avoid housing stocks and pull back a little from retail.
Daily Chart of the SPDR Homebuilders ETF (XHB) — Chart Source: TradingView
The Bottom Line
As discussed, our short term plan is to remain bullish with a focus on retail and tech. We may need to wait before adding more “stay at home” stocks again, but there are other opportunities in travel and entertainment that should keep us busy.
In the longer-term, slow employment and high interest rates could drive us to shift our strategy and add some hedges, but we don’t see that becoming an issue until the end of the first quarter.
This week is also the start of the fourth quarter earnings season. Citigroup (C), JPMorgan (JPM) and Wells Fargo (WFC) will all release earnings on Friday morning, and the data will tell us a lot about credit, spending, defaults and earnings growth.
Expectations are incredibly high for 2021. According to Zacks Research, earnings are expected to be up 23% in 2021 versus 2020. That is a big jump, so if the banks throw any cold water on those estimates with a more cautious outlook, then a retracement or correction becomes a lot more likely in January.
We will keep you informed as the data is released.
John Jagerson and Wade Hansen