The stars are aligning for more explosive stock gains - and one expert has identified the perfect trade to take advantage
- Stocks have skyrocketed since Dec. 24, and BTIG chief equity and derivatives strategist Julian Emanuel says they could go substantially further based on previous rallies.
- While some investors have raised doubts about the rally over the past few months, Emanuel says the market made even more dramatic recoveries from selloffs in 1990 and 1998.
- Emanuel is especially bullish on one part of the market he says will benefit if the Federal Reserve decides to cut interest rates later this year, which is his base-case scenario.
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The stock market's post-Christmas rally has shocked a lot of observers. But Julian Emanuel, the chief equity and derivatives strategist for BTIG, says it might be a long way from ending.
Emanuel says that despite doubts from some experts, this recovery could end up looking like even larger surges that occurred in 1990-91 and 1998-99.
The S&P 500 has climbed 24% since Christmas Eve as the Federal Reserve paused its cycle of interest rate hikes, while investors grew more optimistic about continued economic growth and a resolution to the US-China trade war. The benchmark index is now about 1% away from matching its all-time high from September.
And Emanuel thinks further gains are ahead. He notes that the S&P 500 rallied 30% in the year after its October 1990 low, and after its bottom in August 1998, it gained 45% in 14 months.
That said, the latter gain formed a large part of the tech bubble that burst in early 2000. And while Emanuel acknowledges the kind of rally he's predicting might be the last gasp of the 10-year-old bull market, he says that shouldn't stop investors from buying in the immediate term.
"The extremely inexpensive cost of options for both tactical downside hedging near-term and strategic upside exposure long term make it plausible for investors to continue with the trend with the knowledge that some of the biggest gains (1999-2000, 1987, and others) come in the closing days of extended bull runs," he wrote.
After the Fed went "on pause" early this year, some observers think it's going to start cutting interest rates before long. Emanuel agrees, and he expects the Fed to reduce its benchmark rate in September and December. He notes that rate cuts also bolstered the 1990-91 and 1998-99 rallies.
"If the Fed can successfully achieve its goal of engineering a "soft landing" the market could see further upside this year, with Financials outperforming on the back of higher long-term rates and a steeper yield curve," he wrote in a note to clients.
To take advantage of that potential jump for banks, Emanuel is advising investors to buy January call options on an ETF that tracks the financial sector. He said the bank sector often outperforms months before the Fed starts lowering interest rates as investors begin anticipating its course.
This chart sheds light on the reason for that outperformance: As investors get used to the idea of lower interest rates in the near future, the yield curve, or the gap between short-term and long-term interest rates, get steeper. As a result, banks make bigger profits on mortgages and other loans.
Emanuel said the steeper yield curve contributed to the rallies in the early and late 1990s. He adds that rate cuts, and the Fed's decision to end the runoff of its balance sheet, could make the yield curve steeper in the near future.
That would likely be a big relief after a part of the yield curve inverted in March - something that is often a sign of coming recessions. But Emanuel notes that based on the bounces in the 1990s, a recession could still be years away.