Markets Continue Their Hopium High

The risk-on trade continued into this week, and the markets saw a continued broad-based rally to all-time highs. The S&P 500 closed the week up 1.6 percent, and the NASDAQ 100 closed the week up 1.8 percent. The Dow Jones Industrial Average was up 1.3 percent, while the much broader Value Line Index closed up 2.8 percent as small-caps continue a massive run. Conventional wisdom is now that “cash is trash.”

We are currently in the heart of earnings season. Thus far, corporate America shows continued resilience. This has fueled continued momentum in stock prices. Short-squeezes abound, and this week they emerged in areas such as cannabis, energy, and biotechnology. Just about any area with high short interest seems to be more than fair game.

An observation is that quality and value across many asset classes is being left in the dust performance-wise. This is particularly observable within the area of big-cap pharma, as well as so many others. We saw the IPO of a popular dating app that closed today at 70X EBITDA. That is only one data point in many that would suggest that, at least near term, the rally is quite extended. Momentum, however, indeed begets momentum. In addition, we heard from Fed Chairman Powell this week, who indicated continued dovishness, and vaccines continue to roll out across the United States in pretty rapid fashion.

Hard assets participated well in the rally, particularly companies that are more cyclically exposed. This was particularly apparent in natural resources. The S&P Global Natural Resources Index had an incredible week, closing up 4.8 percent for the week. Leading the charge after a very difficult year in 2020 was energy. WTI Crude was up 3.6 percent for the week, and is now up 20 percent year to date. The confluence of a demand recovery and supply discipline on the part of US producers and OPEC has produced a perfect storm for a once-crowded short.

Although pricing is sustainable at the $55-60 area in the longer term, I think a more cautious tone is warranted. It is important to look for signs that US activity is picking up in a more material way. This is best accomplished by listening to producer conference calls and understanding what capital budgets will look like for the mega-cap, as well as the independent E&Ps.

The XOP S&P Oil and Gas Exploration and Production Index was up 8.3 percent for the week. The OIH Oil Services Index was up 2.1 percent. Natural gas was kind of an outlier, given the bitter cold temperatures throughout the United States from the “polar vortex,” and closed the week down 2.4 percent.

Base metals had an exceedingly good week across the board. Copper was up 5.9 percent, and set an eight-year high. Zinc was up 4.9 percent, iron ore was up 3.1 percent, and nickel was up 4.9 percent. Platinum had an incredible week, closing up 12.7 percent, which is attributed to hope for its use in the “green hydrogen” economy.

Precious metals prices were a bit more muted. There have been concerns from technicians about an inability to sustain a rally above $1850 an ounce after having had a very strong start to the year. This is of particular concern given dollar weakness, and this is something to watch. It is likely that risk assets are just getting a lot more attention due to strong price momentum, and that is why this rotation continues.

Gold was up 1.8 percent for the week. Silver is participating to a greater degree in a risk-on trade, and closed the week up 2.4 percent. The stocks performed decidedly less well, with the HUI AMEX Gold BUGS Index closing down 82 basis points and the GDXJ Junior Mining Index closing down 2.1 percent. We are beginning to see early signs of company-specific situations that exhibit higher-than-expected cost inflation on capital projects, and this will definitely be something to watch as the cycle wears on.

Alternative currencies such as bitcoin have occupied a great deal of mind share as companies begin to take cryptocurrencies on-balance sheet as “intangible assets” under IAS 38.

More defensive hard assets areas were decidedly mixed. The Dow Jones REIT Index was up 2.7 percent. Performance was dominated by companies that would benefit most from a reopening of the economy. While analysis suggests that there are some permanent impairments in areas such as retail, and perhaps less so in office and other property types, hope for a return to a pre-COVID norm dominates stock price performance.

There is a great deal of capital on the sidelines, and this is likely to result in structurally lower cap rates going forward as companies rush to use cheap capital to consolidate. Infrastructure was up 1.4 percent, and the AMLP Alerian MLP energy infrastructure index was off 85 basis points. Energy infrastructure saw a week of earnings, as well as a hostile bid for a roughly 24 percent premium. The stock trades well above the bid price, which really demonstrates how much value there is in this area.

Continued fiscal and monetary stimulus coupled with earnings momentum and an aggressive vaccine rollout have created a perfect tailwind for the financial markets in general. What is most interesting is the disparity in performance in terms of value versus growth. It is almost as if the more questionable the business model – or, in the case of SPACs, not having a business model at all – the better the performance. Notions around value seem antiquated, and it seems that the less work one does on a company, the better the returns. We are not ready to throw our textbooks out the window, and see areas of compelling value. We have seen all too often that valuations are indeed mean-reverting, and this works both ways.

Best Regards,

David McAlvany
Chief Executive Officer
MWM LLC