QYLD - $5.73 Trillion Reasons To Be Bullish In 2024

2023-11-17 10:28:23 ET

Summary

• Despite overbought market conditions, major averages held gains due to a drop in long-term interest rates.
• Speculation by investors who front-ran the purchase of Nasdaq 100 futures contracts may mark a short-term top.
• Liquidity in 2024 may come from money market funds reallocating to high-quality stocks with attractive dividends.

Despite the overbought nature of the market after a two-week stock surge, the major averages held their gains during yesterday's session in response to the drop in long-term interest rates. The 10-year yield fell 8 basis points near its low for the week to 4.44%. Weaker economic data put downward pressure on bond yields, as weekly unemployment claims came in higher than expected and industrial production fell short of expectations, due to the United Auto Workers' strike. Bears are already starting to circle around reports of weaker economic activity, as if unexpected, to suggest that the recession they have been forecasting for more than a year is right around the corner. They will surely be emboldened when stocks pull back in the coming days to resolve the overbought condition we now face after the November rally.

One reason stocks have continued to levitate this week, other than rampant short covering, is bullish speculation by investors who have front-run the purchase of approximately $8 billion in Nasdaq 100 futures contracts today by a fund that is designed to sell covered calls on the index each month. The Global X Nasdaq 100 Covered Call ETF ( QYLD ) sold some 5,300 call options on the index a month ago to enhance its return. Those are obviously deep in the money and expire today. Therefore, the fund needs to buy futures contracts worth nearly $8 billion to cover or unwind the short position. The buy is occurring as the Nasdaq 100 reaches its high for the year and may mark a short-term top.

This also comes at a time when big technology stocks are the most crowded trade on Wall Street, which makes it less likely they will have a repeat performance in 2024. That doesn't necessarily mean the Magnificent 7 will realize losses, but the other 493 names in the S&P 500 should see better performance, as market breadth improves, and investors go on the hunt for value. Rotation is inevitable as the business cycle evolves, and different segments and sectors of the market revert to their respective means.

One question many investors are asking today is where the liquidity will come from in 2024 to fuel additional stock market gains, especially now that the bond market is offering competition for investment dollars with such attractive real rates of return.

Look no further than the mountain of money that has piled into money market funds this year, which are now paying more than 5%. Yes, that is a risk-free rate of return that is too attractive to pass up today, especially when comparing it to what is available in the bond market or the perceived risk of the stock market. Yet 5% is not a fixed rate. As the Fed starts to normalize monetary policy by lowering the Fed funds rate next year, the variable rate earned on money markets will fall. The record-setting $5.73 trillion that sits in money market funds today will start looking for a different home within investor portfolios. Granted, a large percentage will reallocate to the bond market to lock in fixed rate returns before they fall more significantly, but they are already starting to decline as inflation wanes and economic growth slows.

I expect a significant percentage of this mountain of cash will be reallocated to high-quality stocks paying attractive dividends with yields that compete with falling money market rates. The Magnificent 7 may be expensive, but many of the Mediocre 493 left behind offer significant value at current prices.

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