An ex-Wall Street chief strategist says the market's comeback has made most investors 'blissfully unaware' of its real risks — and lays out 6 reasons why another free-fall is on the cards

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  • Market indexes like the NYSE Composite and Russell 2000 show that stocks have not recovered as much as benchmarks of larger companies indicate, according to Peter Cecchini.
  • Cecchini, the CEO and founder of AlphaOmega Advisors, uses these indexes’ performance to conclude that smaller stocks have actually been in a rough patch since 2018. 
  • “Markets feel as if they are on the cusp of yet another significant risk off correlation event,” he said in a recent note, outlining six reasons for his view.
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It’s easy to look at the biggest indices of US stocks and draw sweeping conclusions about the overall market.

It’s even more tempting to do this because the biggest and most popular companies in the world dominate the S&P 500, Nasdaq 100, and Dow Jones industrial average.  

For Peter Cecchini, looking at these benchmarks alone is a foolhardy way of understanding how the market is really doing. Take the NYSE Composite Index, for example, which is down 8% this year and 6% from its 2018 high. Or the Russell 2000, which is still 12% below its 2018 high and down 10% year-to-date. 

“The truth of the matter is that, since 2018, most US equities have had a rough time of it,” said Cecchini, the CEO and founder of AlphaOmega Advisors, and former global chief market strategist at Cantor Fitzgerald.

In a recent note, he added: “Most seem blissfully unaware of this condition, as the headline indices are dominated by what have turned out to be somewhat countercyclical (at least relative to the pandemic) technology stocks.”

He echoes various other experts, including strategists at JPMorgan, who have raised concerns about the narrow leadership of Big Tech stocks and flagged issues that would spur another marketwide decline.

Without further ado, here are the six risks that Cecchini flagged. While they may not strike you as brand new or unfamiliar, Cecchini says they are not being given enough consideration. 

1. Valuation

Cecchini computes that S&P 500 technology companies — several of which led the post-pandemic recovery — are trading at 31 times their year-end earnings estimates. 

One way to justify these valuations, he points out, is by considering the so-called Molodovsky effect. It explains that price-to-earnings ratios can be unusually high at the bottom of an economic cycle because the profit denominator is also low. In theory, valuations should become tempered over time as earnings rise. 

But Cecchini’s counterpoint is that the ongoing business cycle’s contraction is not over and the expected earnings growth may not materialize. 

2. Monetary policy

The Fed’s response has been the center of much attention due to its size and influence on investor sentiment.

Cecchini is in the camp of experts who believe that the Fed is running out of tools required to deal with another downturn, especially its best-known mechanism of interest rate adjustments. A move to negative interest rates would be “inefficacious at best and harmful at worst,” he said. 

3. Fiscal policy

“Except after the Great Depression, US markets have never been so reliant on policy — especially fiscal policy,” Cecchini says. 

To be sure, markets were confronting the worst macro environment since the depression earlier this year. But Cecchini remains worried about the future tax implications of the cash individuals and businesses received due to the pandemic.

He says it’s almost inevitable that there will be payback in the form of higher taxes — and markets would not find that kind of fiscal policy palatable. 

4. Elections

Investors are not fully acknowledging the real or perceived risk that Democratic presidential candidate Joe Biden would be less business-friendly than President Donald Trump, Cecchini says. Biden recently pledged to undo the current administration’s tax cuts on “day one,” arguing that it would not hurt companies’ ability to hire.   

5. Trade policy

Friday’s news that the Trump administration planned to ban TikTok and WeChat downloads served as a reminder to investors that US-China tensions are alive and well. 

Cecchini considers the trade war as a bipartisan issue that remains in full swing.   

6. The economy

Cecchini says the risk of a double-dip recession are greater than investors realize, for reasons not limited to the uncertainty surrounding a COVID-19 vaccine’s timing and distribution.   

He also tied the economy’s prospects back to the problem of big-tech valuation. If there’s continued improvement in the economy, the enthusiasm for a recovery trade that propped up these stocks could wane. And if the dreaded double-dip occurs, it would likely take these companies down with it too. 

Even after making these six observations, Cecchini acknowledges that he might be dead wrong. After all, investors who ignored stretched valuations and chose not to fight the Fed have been rewarded for their bullish convictions.

Still, Cecchini says these risks have not vanished into thin air because the big indexes suggest otherwise.  

“Markets feel as if they are on the cusp of yet another significant risk off correlation event,” he concluded.

A Global Asset Management Seoul Korea Magazine

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