Going into this year, a theme for our clients was that “the path of least resistance is up, but we could encounter some type of volatility”. This is exactly what we have seen thus far this year, and we continue to believe that this will be the case moving forward.

So, let’s break this statement down into two parts.

  • The Path of Least Resistance is Up – This is the enjoyable part. The market is up over 10% YTD off of massive amounts of liquidity being put into the market – both fiscally and monetary. Just think of all the stimulus that has hit the market. Most Americans are flush with cash and, more importantly, are very ready to spend that excess cash as the economy continues to open. So, given this backdrop, we believe that the market can continue to grind higher.
  • *The second part of that statement, “but we could encounter some type of volatiltiy” is more difficult to endure than the first part because it can create behavior biases. Looking back at history, we know that that, every year, the market tends to see three (3) 5% pullbacks and one (1) 10% correction – the market hasn’t encountered any of these thus far. More importantly, the second year of a recovery tends to see atleast one 10% pullback.

Even though the market has not had a drawdown of 5% this year, we have seen some bubbles from Q1 slowly pop one-by-one over the last few months. From SPACS to high growth tech to crypto, we think the most amazing takeaway of these bubble pops (where hundreds of billions in capital was quickly erased for investors), is that the S&P 500 has done nothing but rally in the face of the following themetic declines:

  • SPACs fell ~30% from Feb to April (SPX rallied 6% during that time)
  • ARKK fell ~35% from Feb to May (SPX rallied 7% during that time)
  • Archegos stocks including VIAC, DISCA, TME, VIPS, etc. fell ~60% from March to April (SPX rallied 5% during that time)
  • Solar/renewable stocks fell ~40% from Feb to May (SPX rallied 7% during that time)
  • Cryptocurrencies fell ~50% last month (SPX flat during that time)

The recent violent sell-off in bitcoin seems to be testing the S&P 500’s “teflon” designation once again, as volatility fear metrics have screamed higher. Even though the SPX is near all-time highs, the equity volatility market was pricing a high degree of fear/anxiety. We’ll see if this time is different, though we don’t believe that it will be.

Let me repeat the biggest takeaway here – The S&P 500 has done nothing but rally in the face of what we consider to be adversity, as many “hot” thematic areas of the market entered into a bear market at one point during the year. Why is this? Well, since vaccine day on 11/9/2020, we have seen the return of the “average” stock, which has underperformed the Mega-Caps for the last few years. Furthermore, we have seen areas of undervalued parts of the market that have been out of favor finally start to outperform on market inflation expectations, i.e., materials (specifically metals & miners).

We think the big questions investors should be asking is – given the blowup in these thematic areas, is there any need to worry about any structural problems within the market? First, we do not believe that these are structural problems in the market – there was momentous froth in these niches areas that simply unwound. Secondly, once we take our Michael Burry cap off, we recognize that not all threats are systemic in this business, and while we’ve likely all read the same accounts of billions of dollars lost on these trades – we’re equally struck by the benign response from credit conditions. We’d favor the idiosyncratic call, not the systemic one.



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