Yes, I know, the S&P 500 is back to all-time highs.
Yes, I know that the big-tech companies are on the move again.
Yes, I know we just passed another $1.9 trillion in government stimulus.
But the pandemic-related gains made in big tech, small tech, big box retailers, green energy and housing/home goods suppliers aren’t really the things driving this rally.
If I go back a week and use a heatmap of the S&P 500, I can show you… It’s plain as day.
Lots of big tech and pandemic names are still faltering — Apple, Nvidia, Netflix — while dumb old energy, basic materials, industrials and financials are crushing it.
If I go back a month, the heatmap… Well, it starts to get ugly.
Lots of red in there… LOTS of red.
Amazon down 8%, WalMart down 9%, Apple down 12%, Nvidia down 14% and Tesla down an incredible 22%.
Moreover, they will have difficult year-on-year comparisons because they won’t benefit from the pandemic like they did in 2020. Instead, their growth will slow down.
So once again, it’s dumb old energy, basic materials, industrials and financials carrying the market load for now.
They’re the ones pushing us up to all-time highs, not the big boys.
And if you want to know the reason behind it, I can just show you this photo I took earlier today.
Source: My phone, Target, Inflationary Pressures
That’s not a typo, I had to spend $65 to get TP and paper towels earlier today… It’s almost the same size as my monthly cell phone bill.
Inflationary pressure like this is ripping through the economy, and that affects real people.
But it also pushes up interest rates, which help financials.
It is pushing up energy costs, which is helping oil producers.
And in turn, that is pushing up materials costs, which helps basic materials and industrial companies charge more for their products.
But once prices get too high, a funny thing happens… People stop buying.
And that’s already happening in China
When China slows down or stops buying we can see it develop in their inventory data.
For instance, as a proxy for construction, we can use rebar inventories, which are nearing the all-time highs set when they shut down due to the pandemic.
Same with copper inventories…
Iron ore inventories are on the rise…
And crude oil…
And fuel oil…
New orders — or as I like to think of it, future demand — have declined for two straight months.
And these bearish indicators have been part of the reason that China’s stock market has been in free-fall since February.
What people underappreciate in my opinion, however, is that China is the largest trading partner of many countries around the world, including this one.
And as we learned last year, when China’s supply chain starts to bottleneck, bad things can happen.
In other words, problems in China eventually become problems in the United States because they export them to us.
That shipping time takes about a month, which also coincides with the lag between China’s COVID-19 related market crash and ours…
So while I have no idea why the slowdown is happening in China, there’s no denying it exists.
There’s also no denying it could eventually affect our markets.
So we’re selling this rip in non-inflationary names just in case, closing out of Designer Brands Inc. (XNYS:DBI) at +27.8%, Bright Horizons Family Solutions Inc. (XNYS:BFAM) at 25.2% and Sun Communities Inc. (XNYS:SUI) at around a 2% gain.
If this volatile period calms down, we’ll be back in those.
It’s also fine to short China large-cap companies here, which can be done through the iShares China Large Cap ETF (ARCX:FXI).
Though I’ve said it before, it bears repeating to always keep losses small. As an example, I use trailing stops anywhere between 3-10%, and I sell incrementally on the way up. Everyone has gotten burned that way a few times… It’s a lesson that has to be learned.
With regards to market conditions — I’m not entirely sure if this blip in China is temporary or the start of a new, more serious downtrend in the markets.
If it’s the latter, it could spread to the rest of the world quickly.
So, I’d rather miss out on a little bit of a run higher than risk a loss.
All the best,