Watch Out for Rain Clouds During this Week’s Bull Parade

The rally we’ve seen the past few weeks sped up this morning, with the Dow up 3% at the open. The Russell 2000 index of U.S. small caps was up even more, a whopping 5%.

Even though we had two investing legends say last week that things were looking bad for both the stock market and the economy.

That’s this week’s Reality Gap. Let me explain…

Look, today’s rally was to be expected. As you saw me saying last week on Fox Business’ Varney & Co., on our own Money Morning Live livestream, and read here in Straight-Up Profits, I had a very consistent message that the Fed’s and Congress’ financial stimulus allowed traders to move markets up above the key support levels, and pushed them up big-time late on Friday.

Then Fed Chairman Powell appeared on 60 Minutes to say that he has plenty of ammunition left if more stimulus is needed, and that the economy could recover over the second half of this year. Two quotes from the Fed Chair were particularly important in driving he market’s reaction. The first was showing that the Fed is not “out of ammunition” to fight further economic downturn: “There’s really no limit to what we can do in lending programs.” The second was an intermediate-term pronouncement on economic possibilities: “Assuming there is not a second wave of the coronavirus, I think you will see the economy recover steadily through the second half of this year”.

And this morning, biotech firm Moderna Inc. (MRNA) announced positive results from its early trial of an experimental vaccine against Covid-19. This Phase 1 study looked only at safety, and there were no significant side-effects among the patients. But the fact that all the patients in the small dose vaccine subset developed antibodies the same as a recovering Covid-19 patient really stoked the stock markets.
Here’s the market’s reaction to both events:

The mood, in other words, is bullish. (cue Beach Boys music…)

It’s so bullish, in fact, that headlines are starting to leave out some nuance.

Powell, for example, predicted that the economy would recover over the second half of the year if there is no second wave of Covid-19 cases as America reopens.

If we do see a surge, Powell sees the recession lasting until the end of 2021. That’s a much gloomier possibility.

And he’s not the only one thinking that. On Tuesday, investing legend Stan Druckenmiller called the idea of a rapid, V-shaped recovery a “fantasy.”

The next day, one of the best-paid hedge fund managers in the world, David Tepper, said stocks were more overvalued than at any point in his life other than in 1999.

Traders sold off a bit on these comments last week, but quickly got back in the game.

It may look like traders are pushing stocks higher with their eyes closed, choosing to ignore warnings about the strength of the economy.

But the reality is different. Money managers with billion-dollar portfolios such as Druckenmiller and Tepper are always looking at what’s going to happen over the next few months and years.

That’s what you have to do to balance a portfolio of that size. With that longer-term perspective, it’s only natural that they’re cautious and sounding the alarm.

But us traders, we’re looking at short-term trades, out a week or two (maybe a month, tops). We need to be bullish, as the two tailwinds of stimulus and good news is pushing us ever higher.

In fact, it looks like we may finally break out of the trading channel we’ve been bouncing around in for over five weeks this week.

There’s very little that can stop this feel-good rally right now. States only just began reopening, so it will be a week or two before we really see if there’s a spike in infections or not.

In the meantime, there are no big earnings coming out that could sour the mood.

The only fly in the ointment is the return of last year’s trade dispute with China. On Friday, the White House clamped down even harder on Chinese telecom giant Huawei. It is now illegal for any company, anywhere in the world to supply Huawei with semiconductors made using U.S. technology, unless they first obtain a special license from the Commerce Department.

This morning, one of the largest chip makers in the world announced they would comply with the new rule. Taiwan Semiconductor Manufacturing Co. Ltd. (TSM), often called TSMC, has stopped taking new orders from Huawei. That’s despite Huawei being TSMC’s second-largest client, accounting for 15-20% of revenue.

This trade dispute could quickly escalate into a “cold trade war,” as a Jefferies analyst called it. The Global Times, a Chinese government-run newspaper, has already threatened to put Apple Inc. (AAPL), Cisco Systems Inc. (CSCO), Qualcomm Inc. (QCOM), and other U.S. tech giants on blacklist, restrict their operations in China, and so on.

More news like this is what could dampen this short-term feel good rally.

In the meantime, there are some earnings to keep an eye on this week. Walmart Inc. (WMT) kicks things off today, with The Home Depot Inc. (HD) and Target Corp. (TGT) following tomorrow. Nvidia Corp. (NVDA) reports on Thursday, and it will be interesting if the stock’s lockdown rally will end even on a good earnings report, like Netflix Inc.’s (NFLX) did. Finally, Alibaba Group Hldg. Ltd. (BABA) reports on Friday, which should give us a good view of how well China’s economy is restarting.

Great trading, stay safe out there, and God bless you,

D. R.

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