Don't Be Fooled by the Financial Media With This 'Measure' of a Market Top

The financial media still isn't clued in to the reality of the stock market...

Just last week, we mentioned that many investors are putting the cart before the horse and becoming skittish over potential interest rate hikes.

They're concerned that higher rates could mean companies will avoid borrowing money to invest in growth. Higher rates could also push the market discount rate higher. Both of these actions risk driving the market lower.

With high rates, investors can theoretically put their money in high-return bonds or savings accounts and only invest in the market at more attractive prices.

As the argument goes, with a heightened risk of inflation coming in 2021 and beyond, the U.S. Federal Reserve's best tool for keeping prices in line is raising rates.

Raising rates also gives the Fed "ammo" for the next crisis. By having high rates before a crash, the Fed can aggressively cut rates to encourage spending.

Many op-eds, news anchors, and pundits are looking to chase a story on potential rate increases... And they're creating lots of fear about the market.

The reality is, they're missing the point.

With rates near all-time lows, modest short-term rate hikes won't cause the stock market to come crashing down. Historical analysis shows the exact opposite is true.

The Fed raises rates when it expects strong economic growth, which drives corporate earnings growth. As we said last week, the Fed raising rates is actually a bullish signal for the stock market in the short term.

Barron's recently came around to the right idea on interest rate risk...

It recently published a piece on why an increase in interest rates won't cause the economy to come screeching to a halt.

However, Barron's has substituted this concern with another – explaining why it believes the stock market is a bubble about to burst...

It reported that investors should be spooked by the large amounts of equity being issued by corporate management teams. Barron's specifically highlighted battery developer QuantumScape (QS), electric-truck maker Nikola (NKLA), and cannabis company Canopy Growth (CGC) as three names that have used the recent rally to raise capital at attractive prices.

As Barron's argues, management teams traditionally love to try and time the top of a market to secure the best possible price for an equity issuance. If they issue stock at what they think are inflated values and turn it to cash, they can "lock in" their position.

Given that management teams know the most about their companies, this could be a first sign that the market could be turning.

Of course, the reality is different...

As any analysis of share buybacks and share issuances would show you, management teams have a habit of buying back shares at peak valuations and selling them at trough valuations. But leaving that aside, this still isn't a reason to panic.

While management looking to raise equity can be a powerful signal when studied in context, those companies raising massive amounts of equity means little for stock market valuations today.

We've seen a noticeable jump in equity issuances on a six-month rolling average over the past year, but this isn't because management teams think the end is in sight.

In fact, the first spike in equity issuances came during March and April last year – right at the bottom of the market, not the top. When government stimulus was still in the works, companies needed to source money any way they could simply to stay afloat.

Furthermore, the current low-rate environment has made special purpose acquisition companies ("SPACs") a popular choice for investors over the past few months. These companies offer an alternative to the traditional initial public offering ("IPO"), and investors piled into the sector in 2020 and earlier this year. Sizable equity raises for new SPACs have driven up this number as well, as have secondary raises for these companies when they have undergone mergers to take their target business public.

Management teams at blue-chip companies across the S&P 500 Index aren't running to source new equity raises...

Barron's has picked three specific stocks with equity raises that have seen recent speculative runs.

These stocks have little correlation with the market as a whole. Perhaps instead of calling the top of the market, the management teams are just calling the top of their own stocks...

QuantumScape is currently working to develop a next-generation solid-state lithium battery. However, the company doesn't predict seeing profitability for years to come... So it needs a lot of capital to fuel its investment.

Meanwhile, Nikola is currently being investigated by the U.S. Securities and Exchange Commission ("SEC") and the Department of Justice over securities fraud allegations. It's another early lifecycle company starved for capital.

Finally, Canopy burned through a mind-boggling $3.3 billion of cash in 2019 and 2020 trying to turn profitable. Rather than looking for a top, Canopy is grasping for any means it can to stay afloat.

Instead of providing a warning to heed, Barron's is barking up the wrong tree. This is just another example of the financial media looking for a story without giving the context to anchor the data.

Regards,

Joel Litman
April 26, 2021