The stock market's historic surge to fresh highs over the past two months is without precedent and nearly devoid of any fundamental support. It's been driven instead by a powerful but unhealthy combination of hope for more cheap money stimulus, panicked short-covering and central bank asset purchases.
With monetary methamphetamine being injected into the veins of the global financial system at a record monthly run rate, and with the Federal Reserve likely to hold off on any fresh rate hikes until after the U.S. presidential election — despite what New York Fed President William Dudley suggested Tuesday, the low-volatility/low-volume melt up could very well continue through the end of the year.
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If so, investors would do well to consider areas of new strength, including homebuilders, retailers, foreign equities and forlorn new-tech favorites. It’s also a good time to think about trimming profits in areas that look overextended, including mega-cap tech plays like Apple (AAPL). This is the advice of Bank of America Merrill Lynch analysts, who in a recent note to clients admit that the stock market rally has separated badly from hard fundamentals like profits or factory orders. But until conditions, including undeniable inflation pressure or political upheaval, force monetary policy tighter, this isn't likely to change.
The final stage of this rally, in their view, should witness a classic rotation of capital into recent market laggards as investors turn from a focus on deflationary risks to rising chances of a burst of inflation. Based on market moves on Monday, this rotation has begun. Speaking generally, this should benefit: Rest-of-world equities, financials, gold, commodities and value stocks.
A perfect example of this was the upside breakout in the Shanghai Composite Index, which punched out of its year-long funk with a break above its 200-day moving average, a measure of long-term trend, for the first time since last summer. The country's structural problems, such as overindebtedness and overreliance on fixed-asset investment and exports, haven't changed. Investors are merely putting money into assets that don't look overvalued.
Crude oil's recent strength is similarly powering fresh buying in peripheral beneficiaries such as Russian equities and U.S. regional bank stocks.
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While U.S. GDP growth has been weak, investors are focusing on the singular bright spot of consumer spending to bid up retail stocks despite ongoing revenue declines in the industry. The justification? A recent focus by retailers on controlling expenses leaves the group primed for a strong holiday shopping season as Americans respond to persistent job market strength and nascent evidence of wage inflation.
JCP 200-Day Simple Moving Average data by YCharts
Just look at the surge in JCPenney (JCP) and Macy's (M). JCPenney reported a loss of nine cents per share last week. Macy’s announced it was closing 100 stores after sales declined 3.9 percent from last year. But results beat lowered expectations and new initiatives, like appliance sales at JCPenney, are generating excitement.
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And finally, bulls on the prowl for value are coming back to one-time post-IPO favorites that have been relegated to the dustbin, such as Twitter (TWTR) and GoPro (GPRO). GPRO is recovering from the disastrous HERO Session camera as investors look ahead to the rollout of the Karma video drone and Hero 5 camera.
Twitter, amid its long struggle with user growth, engagement and management turnover, has popped back over the $20-a-share level thanks to ongoing chatter that the company could be sold and reports that the service will receive app support on the Apple TV device. The breakout represents a 50 percent gain from the stock's June low.