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Stocks Explode Higher - A Breakout To New Highs On Deck?

The S&P 500 ripped higher by 7.32% this week with Friday's close at 3,509.44.

Friday's close is a new all-time high weekly close for the index. If the title of last week's Update was "Boom or Bust", then the title of this week's is clearly "Stocks Boom". Last Sunday we never imagined we'd be writing about a 7.32% weekly advance for the S&P 500 this Sunday, so let this week's price action serve as yet another reminder that the price of the S&P 500 trades beyond the limits of imagination.

If the price action for all of 2020 is a bit mystifying, this week only adds to the mystery. The election has turned out to be rather chaotic, as many believed, and uncertainty still remains over who controls the senate, yet the market priced this week like a true stock market utopia is upon us. The S&P 500 gained more than 1% four consecutive days this week (Monday through Thursday), something that's only happened three other times since 1950 (10/11/1982, 10/14/1974, 06/01/1970).

The index also erased all of last week's -5.64% "sucker punch". A two-week pattern where the S&P 500 declines -5% or more and then gains all of it back (and then some) the very next week has only occurred four other weeks since 1950 (7/9/2010, 3/13/2009, 11/28/2008, and 10/31/2008). The upside price thrust this week was rather remarkable, and it further exemplifies the "on/off" switch the market has demonstrated the last five years. It also adds to the growing list of "V" bottoms following sharp price declines, perpetuating belief in the meme that "stocks only go up".

So, where are we now? Ironically, we're in the exact opposite position we found ourselves in last week. We closed last week hanging on by a thread above September's low, and we closed this week knocking on the door of September's high. Importantly, we're still range-bound, we haven't broken out to the upside yet. While sentiment has done a total 180, it's important to note that the price action over five days isn't the be-all and end-all of what lies ahead. After all, there was absolutely no follow-through to the downside from the prior week's -5.64% decline.

The best we can say at this point is that we're now in position to test and break out of the range - if there's follow-through to the upside over the week(s) ahead.

That is still a huge "if" as trading ranges are notoriously difficult to forecast. A breakout to the upside does feel inevitable at the moment, especially given where we are in the calendar year in terms of seasonality, but we'll need to see it to believe it.

From an internal perspective, the chaos surrounding the election only manifested itself in reinforcing more of the major price action theme we've seen for years - the largest market capitalization sectors like technology, health care, and consumer- oriented sectors dominating, while the smaller market capitalization sectors like energy, real estate, and utilities pull up the rear.

The S&P 500 Technology Sector (SPT) gained 9.70% this week and increased Monday through Friday. Health care gained 8.25% and closed at a new all-time high weekly close, and the consumer discretionary sector added 7.39%. Meanwhile, the energy sector gained 0.81% for the week. The bifurcation across market sectors continues, for now. It's imperative that your portfolio is somewhat diversified, but it's also imperative that your portfolio emphasizes the areas showing the most relative strength.

From a volatility perspective, the chaos surrounding the election manifested itself in plunging volatility expectations. The Volatility Index (VIX) declined 13.16 percentage points, or -34.61%, this week, falling from 38.02 to 24.86. This is after gaining 10.47 percentage points, or 38%, the week prior. It's clear market participants, collectively, were hedging the event risk associated with the election. While that was the prudent thing to do, it clearly wasn't the profitable thing to do (hindsight bias!). Nonetheless, since 1990 there are only five other weeks where the VIX declined by -10 percentage points (4/3/2020, 07/01/2016, 11/28/2008, 10/31/2008, and 09/28/2001). The "Brexit" fiasco from 07/01/2016 might represent the closest parallel, and the S&P 500 was onward and upward from there, rising ~3.5% the next three weeks.

Alternatively, we can also quantify this week's price action in both the VIX and S&P 500 by defining it as a calendar week where the S&P 500 gained 3% or more and the VIX closed above 20 and below its upper Bollinger Band after having closed the week prior above its upper Bollinger Band.

Since 1990 there are only 10 trading weeks that match, but we were surprised with just how mixed the S&P 500's forward one-month returns were since we thought this study would skew far more favorably (i.e., a lot more white on the table below, as if weeks like this are an all-clear sign). Astute observers will notice that this is the first time this has occurred with the S&P 500 closing the week at a new all-time high weekly close, so this time is different in a way.

As always, 10 trading weeks can't predict anything, but they can be used to dispel the myth that the price action this week is an all-clear sign for the short term. It's just not that easy. There is no all-clear sign, and the the short-term forecast remains cloudy. That said, the clouds will clear on a decisive breakout to new all-time highs. Hopefully we'll be writing about that next Sunday!

S&P 500 Primary Trend - Up, Back In Drive?

Our work continues to label the primary trend as up, or "bullish".

The month of November is off to a torrid start, rising 7.32% through the first five trading days of the month. This marks the second strongest opening five days of a calendar month since August of 1984's advance of 7.99%. As of Friday's close, we're trading above our all-time high monthly close at 3,500.31. Put simply, if we don't close the month of November at a new all-time high then the month will be remembered as a huge disappointment.

We tend to follow a theme with our weekly commentary. We prioritize the "trees" in the first section, sharing our thoughts on the S&P 500's outlook over the short term, and then we move to the "forest" in the next section, where we always speak to the S&P 500's primary trend. In our view, the primary trend is easily the most important trend for long-term investors.

Having a rules-based, systematic process that is used to identify and define the primary trend is the key ingredient to prudent portfolio construction, or asset allocation decisions, for long-term investors.

And if there's one rule history has taught us, or that "evidence-based investing" emphasizes, it's that during a primary uptrend for the S&P 500 long-term investors are best served investing in the most traditional sense of the word. Primary uptrends are a time to buy 'em and hold 'em, nothing fancy is required, at least not until the primary trend is no longer labeled as up, or "bullish".

With the outcome of the election and the S&P 500's subsequent burst to the upside now behind us, we can ponder the bigger picture, or the "forest" to continue the analogy. First, it's important to reiterate that this week's price thrust to the upside is driven exclusively by the actions of market participants, from the retail investor buying a call option on their favorite stock, to the hedge fund investing billions into baskets of exchange-traded funds, to the market maker on the other side of both of these transactions.

Importantly, the actions of market participants are a reflection of the collective expectations of said market participants, with their expectations being a derivative of the work that's been done to analyze and evaluate a specific investment.

While the price action may not make sense, and we never truly know why the market does what it does, especially when it's borderline bi-polar week to week, there is only one reason market participants, collectively, buy stocks in the present. It's because their work leads them to the expectation of higher stock prices into the future.

Why might they feel this way at the moment? Because it's easy to envision that we're in a better place over the coming 6-12 months: from the coronavirus, where the probable path will be cases descending, therapeutics, and a potential vaccine, to our daily lives and spending habits, which will rotate and trend back toward "normal". It's also easy to envision a gigantic stimulus package being passed in the not too distant future, the size being the bigger unknown. It's easy to envision the Federal Reserve continuing to be as accommodative as possible the next 6-12 months. They echoed more of the same this week (click here). And it's now even easy to envision there being a steady calm out of Washington, especially if the Republicans hold on to the senate, which likely eliminates the possibility of tax hikes and creates gridlock.

Put it all together and it's hard not to be of the opinion that the future is a lot brighter than the present.

This is probably why stocks have done so well the last seven months, and this is why stocks will probably do well the next seven months. It pays to be an optimist in the world of long-term investing, especially when the null hypothesis is indeed that "stocks only go up" (on a long enough time line). It's impossible to dispel the null hypothesis without evidence, and right now there isn't any sufficient evidence that stocks are vulnerable to a large drawdown in the near future. Not when we're in prime position to close the month of November at a new all-time high.

So, we encourage all of our readers to never let the fear of striking out keep them from stepping up to the plate. While it might feel like "we're doomed", we're probably not doomed. Stocks remain the cleanest shirt in a basket of dirty laundry, and there is no telling just how high they can climb.

Interest Rates Show Volatility, Gold Finds A Bid

The yield associated with a 10-year United States Treasury bond (UST10y) declined -5.68% this week with Friday's close at 0.83%. UST10y traded as high as 0.90% on Election Day, only to then sell off meaningfully into Thursday's low at 0.74%. Bonds sold off on Friday, leaving UST10y almost exactly on its 200-day simple moving average at 0.82%.

The overall structure of the trade this week continued to perpetuate "resistance" in the 0.90% region, i.e. participants, collectively, are eager to own 10-year United States Treasury bonds when they're priced to offer 0.90% in annual interest. That said, we have a series of higher highs and higher lows since August, and there appears to be growing confidence in the "reflation" trade. Higher interest rates across the curve are on the table as we head into 2021.

The interesting part of the interest rate environment at the moment is the circular box the Fed has painted themselves into. They have openly stated they want more inflation, and they've acted as if their true mandate is to "inflate or die" via a willingness to print at will and monetize any and all Treasury issuance. However, higher inflation should, in theory, lead to higher interest rates across the yield curve.

Now, the Fed has openly stated they want to anchor the short end of the curve, i.e. no increases to the federal funds target rate any time soon, so they're effectively welcoming a scenario of a much steeper yield curve into the future. That said, a steeper yield curve operates as a tax on businesses and consumers and serves to slow the velocity of money, which in turn can then stymie inflation. And therein lies the conundrum, and the only way that we can see the Fed being able to find its way out of this conundrum is to implement yield curve control (YCC, click here).

YCC will effectively distort, or disconnect, the relationship between interest rates and forward-looking economic and inflation expectations.

It will allow the Fed to let negative interest rates run, which helps create momentum in an inflationary backdrop based on keeping the pedal to the metal both economically and on the velocity of money. Importantly, this will minimize the likelihood of interest rate shocks and also ensure the era of "TINA" (an acronym for "There Is No Alternative") can sustain. It's in this environment where the wealth effect is also optimized as we envision stocks and property prices rising meaningfully in nominal terms amid this backdrop. We'd anticipate this bringing any and all "bond vigilantes" into the arena, but we're not sure the "bond vigilantes" will have any problem selling their holdings to the Federal Reserve (YCC is predicated on the Fed buying any and all Treasury bonds at a price that targets their desired yield).

Putting it together, our takeaway is that the bond "bull market" is probably dead.

The iShares Core U.S. Aggregate Bond Index (ticker symbol AGG) has produced annualized returns of 5.18%, 4.11%, and 3.55% the last three, five, and ten years. It's been an amazing run, but we doubt we'll see anything close to these returns into the future.

The implications of YCC are very, very favorable for gold in our opinion.

Gold gained 3.82% this week with Friday's close at $1,951.70. Gold appears to have bottomed, finding meaningful support in the $1,850-$1,875 price region (yellow shaded region on the chart below). In any scenario where the rate of inflation is likely going to be greater than the yield associated with long-term Treasury bonds, and where the Fed will openly abuse the United States dollar via quantitative easing forever, we think gold is going to move higher in response. We've been very favorable about gold's prospects since the summer of 2019, and so far we've been rewarded. We continue to believe most growth-oriented long-term investors should have an allocation to gold within their portfolio.

Three Post-Election Booms: Gambling, Solar, and Marijuana

Three areas of the market absolutely took off like a rocket ship after the election this week. We believe these themes should be on everyone's radar as we think about what areas stand to gain the most from a Biden administration.

Sports Gambling: Draftkings (DKNG) and Penn National (PENN) explode

It's been easy to gamble on sports for a long, long time, but it's now likely that it's going to be legalized in all 50 states over the years ahead. Hey, if you can gamble on stocks via options, why not be able to place a wager on Notre Dame beating Clemson? DKNG was up 19.55% this week.

Similar story for Penn National Gaming (PENN). PENN was up 18.30% this week. They have the momentum of Dave Portnoy whose personal stock has skyrocketed in 2020 given how he's monetized his viewership through the quarantine. Relative to DKNG, PENN is certainly the adult in the room, but it will be interesting to see who wins this battle for market share over the years ahead.

Solar Stocks Surge

Solar stocks, as measured by the Invesco Solar ETF (ticker symbol TAN) gained 9.86% this week. While its weekly return wasn't all that stellar, it gained 17.16% from Wednesday's low into Friday's close. TAN has been on an absolute tear all of 2020 and the trend here doesn't appear to have many headwinds in front of it.

Marijuana Stocks Get High (Pun Intended)

The ETFMG Alternative Harvest ETF (ticker symbol MJ) gained a whopping 27.43% this week. Like sports gambling, legalization is a thing. MJ has been a giant dog for years, perhaps its day in the sun is here.

Happy Sunday!

Steve & Rick

This material is being provided for client and prospective client informational purposes only. This commentary represents the current market views of the author, and Nerad + Deppe Wealth Management (NDWM, LLC) in general, and there is no guarantee that any forecasts made will come to pass. Due to various risks and uncertainties, actual events, results or performance may differ materially from those reflected or contemplated in any forward-looking statements. Neither the information nor the opinions expressed herein constitutes an offer or solicitation to buy or sell any specific security, or to make any investment decisions. The opinions are based on market conditions as of the date of publication and are subject to change. All data is sourced to stooq.com and stockcharts.com. No obligation is undertaken to update any information, data or material contained herein. Past performance is not indicative of future results. Any specific security or strategy is subject to a unique due diligence process, and not all diligence is executed in the same manner. All investments are subject to a degree of risk, and alternative investments and strategies are subject to a set of unique risks. No level of due diligence mitigates all risk, and does not eliminate market risk, failure, default, or fraud. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable, or will equal the investment performance of the securities discussed herein. The commentary may utilize index returns, and you cannot invest directly into an index without incurring fees and expenses of investment in a security or other instrument. In addition, performance does not account other factors that would impact actual trading, including but not limited to account fees, custody, and advisory or management fees, as applicable. All of these fees and expenses would reduce the rate of return on investment. The content may include links to third party sites that are not affiliated with NDWM, LLC. While we believe the materials to be reliable, we have not independently verified the accuracy of the contents of the website, and therefore can't attest to the accuracy of any data, statements, or opinions.

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