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Equity bulls take a short break

11 February 2021

US stocks fluctuated between gains and losses on Wednesday, ending the day little changed from Tuesday’s close. US and European futures contracts are also directionless as investors assess whether to take some profits after decent gains or continue riding February’s uptrend. Meanwhile in Asia, there is little activity with markets in China, Japan and South Korea closed for holidays.

Inflation data has become the most-watched economic indicator given all the arguments around its longer-term projections and its impact on financial markets. Yesterday’s US core consumer prices showed little reason to be worried as prices remained flat in January compared to December.

While rising inflation may be problematic, it doesn’t seem to be a considerable risk at the moment. Even if prices begin to rise towards and above 2% gradually, this isn’t going to scare equity bulls. Fed Chair Jerome Powell made it clear yesterday that monetary policy will remain loose until the economy reaches maximum employment. He also wants inflation to reach 2% before even thinking of tapering policy.

Long term bond yields eased significantly with the US 30-year Treasury yields dropping nine basis points from Monday’s high of 2% and the 10-year yield declined six basis points from its high. As long as yields do not rise sharply and economic data along with corporate earnings continue to improve, there doesn’t seem to be a lot to worry for equity investors.

However, they need to display some discipline in their trading decisions and not just follow the herd. Some parts of the equity market are running hot, especially those driven by Reddit traders. Cannabis companies are the latest stocks on Reddit’s radar and that’s driving many in the sector beyond any justified valuations. Investors need to be aware of those stocks that are totally disconnected from their fundamentals. There’s no harm in taking profits out for those who were already exposed to the sector or managed to get in early.

The current environment will continue to support further gains for the broader market as few care about overstretched valuations in a near zero interest rate regime. However, markets do not move in straight lines and a 5% to 10% correction could happen any time soon. Building downside protection and taking some profits may be something to consider in the short term.



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