Euphoric U.S.
Stock Market and Pandemic Plagued Economy in Total Opposition
By the Curmudgeon
Introduction:
The disconnect between the
euphoric U.S. stock market and struggling real economy has never been greater. Despite a pandemic that has killed more than
300,000 people, put millions out of work and shuttered businesses around the
country, the market is now somewhere between euphoria, nirvana, and utopia.
Institutional investors who
have been bullish for much of 2020 are ignoring what’s
happening in the real economy and continue buying stock because “the market is
going up.” They are comforted by the
Fed’s continued zero interest rate policy (ZIRP) and monthly buying of about
$80 billion worth of Treasury debt and $40 billion in mortgage-backed
securities. The Fed has indicated that
program will remain intact for an indefinite time period.
Individual investors have
piled into the market this year and are trading stocks at a pace not seen in
twenty years. That’s driving a significant part of the
market’s upward trajectory and is evident in recent frothy IPO prices,
which we described in this article. Brokerage houses say strong demand from
individual investors drove the surge of trading in Airbnb and DoorDash
– neither of which are profitable. Professional money managers largely stood
aside, astonished and in awe at the prices smaller investors were willing to
pay.
Let’s take a
deeper look at what’s happening in the markets and real economy and offer our
thoughts on same. In a companion piece,
Victor provides a Perspective
on Monetarism, Valuations and Manias.
Examples of High Valuations
and Speculative Excess:
· The
trailing 52 week price-to-earnings (P/E) ratio for S&P 500 index is
39.94 while last year it was 25.23 (source: Wall Street Journal). The last time that market index was at or
above that level was in 2000.
· The
current Shiller PE Ratio is 33.71, which is
more than double the median of 15.1 and the mean of 16.3. It’s based on
average inflation-adjusted earnings from the previous 10 years and is also
known as the Cyclically Adjusted PE Ratio (CAPE Ratio).
· The Tobin
Q ratio (the ratio of the market value of equities to the net worth of
corporations at replacement cost) is at an all-time high in both adjusted and
non-adjusted terms. Both measures are
above previous highs in 2000. Please see Tobin Q graph below.
· Russell
2000 (small) companies should be hurt more than large caps by the COVID-19
lockdowns, business closures, restrictions, etc. Nonetheless, Russell 2000
stocks have rallied like a rocket ship! The small cap index has gained 102% off
its March 18th low, only the second time it has doubled off its
bottom in its entire history. It was up
over 18% in November – a new record. All
that came with no corrections or backing and filling, let alone a test of the
March lows. According to the Biryani
Associates, the current FORWARD 12-month P/E for the Russell 2000 is 79.96. The trailing P/E cannot be calculated
since there was a cumulative loss (e.g., negative earnings).
· Individual
speculators have returned to the market in mass, for the first time
since the dot com bubble. For many, trading stocks started as
a way to indulge their speculative itch when other avenues, such as
sports gambling, were shut down. That
has continued unabated as stocks continued their inexorable trend higher this
year.
· Small
specs are throwing money at trendy, tech-focused companies, which are relatively
new and unproven. Their favorites include cloud computing software maker Snowflake,
the online surveillance company Palantir and the energy storage company QuantumScape, which is up 144% in December alone.
They also like Etsy, the online marketplace, which is up 330% this year.
Just over a week ago, 908 Devices — a maker of hand-held analytic
devices — rose about 150% in its trading debut.
· For IPOs
in December, shares on the first day of trading skyrocketed 87%, on
average, as of the week that ended Dec. 18. That’s the
highest since early 2000, when the dot com bubble began to burst.
· Tesla, a
darling favorite of retail investors (and panned by most hedge funds) joined
the S&P 500 on Monday. It’s up 691% this year, giving it a market value of
more than $600 billion and bloating its price-to-sales ratio to 22 from 3 at the
beginning of 2020.
· Options
trading exploded this year as individual investors flocked to the stock market. A
record number of options contracts have traded this year. An average of 29
million contracts changed hands each day this year, a 48% jump from 2019,
according to data from Options Clearing Corp.
The volume for U.S. call options also hit an all-time
record. The 20-day moving average of call volume just surged past 22.5
million contracts. That’s up 30% from the previous
quarter and more than twice last year’s volume.
· Citibank
Panic/Euphoria Model—which factors in a number of
metrics from options trading to debt—has reached the highest level since 2000
at the peak of the dot com bubble.
Citi’s Tobias Levkovich warned: “Current
euphoric readings signal a 100% probability of losing money in the coming 12
months if we study historical patterns.”
· Bank of
America’s December Fund Manager Survey was the most bullish of 2020
as vaccine hopes induced a strong “buy the reopening trade.” Positioning
continues its climb towards “extreme bullishness” with the BofA Bull & Bear
indicator up to 6.7 (“extreme bullish” level of >8.0). Cash levels fell to
4% and triggered the FMS “sell signal.”
· Margin
debt expanded to a record $722.1 billion through November, according to the Financial
Industry Regulatory Authority, topping the previous high of $668.9 billion
from May 2018. If collateral falls below a certain threshold, a margin call is
triggered. Margin speculators then have the option of either putting up more
money or selling the securities underlying the loans. That always exacerbates downside volatility.
· High
yield bonds have extremely low credit quality, and the yields are
comparatively very low. A record number of companies
have been rated CCC this year, and these are the bonds that have appreciated
most in 2020. Trying to evaluate junk
bond yields and spreads
to true default risk has
been rendered a useless exercise.
· The volume
of debt that U.S. companies have taken on this year has come to an
unprecedented $2.5 trillion and has pushed the debt-to-equity ratio to
record highs. The markets seem to be saying that corporate (and U.S.
Treasury) debt never has to be repaid.
SOURCE: Yardeni Research Inc.
…………………………………………………..
Don’t Fight
the Fed:
Fed Chair Jerome Powell said
on December 16th that the Fed would keep short term interest rates
at rock bottom (0 to 0.25% Fed Funds rate) and continue to buy Treasuries and mortgage-backed
bonds for the foreseeable future. That amounts to a powerful tailwind for the
stock market.
“You have this grand maestro
up in the front that’s conducting the orchestra,” Mike Lewis, head of U.S. cash
equities trading at Barclays in New York, said of the Fed’s easy money policy.
“And until they stop, the music is going to continue to play.”
That quote is reminiscent of
former Citigroup CEO Chuck Prince’s infamous quote in a July 2007 interview
with the Financial Times. He told the FT: “When the music stops, in terms of
liquidity, things will be complicated. But as long as
the music is playing, you’ve got to get up and dance. We’re still dancing,” he
said. Please see End Quotes and last
sentence of this post for more on the music still playing.
Economic Assessment and Market
Outlook:
Current pandemic lockdowns and
restrictions will continue. More will
likely be enacted this winter.
Consequently, adverse economic effects are likely during the 1st quarter
of 2021. Moreover, the sizable monetary impulse and fiscal stimulus did not
feed into the real economy.
Economic indicators, such as
loan demand, are contracting again. Consumer spending is weak, household income
is falling, and millions remain unemployed with unemployment insurance expiring
for many.
Yet the financial markets
ignored all of the chaos and suffering of this
dystopian present and are instead look forward to a utopian future. Indeed, U.S. equities are priced for
perfection and market participants are extremely bullish.
As per the B of A bullet point
above, sentiment gauges across the board are recording extreme bullish
sentiment, low cash ratios, and high equity exposure all at the same time. The
popular opinion is that nothing can take the equity market down if a pandemic
and the severest recession since the Great Depression couldn’t.
What could possibly go wrong
to derail the bullish trend? We don’t know, but as Victor has opined numerous times over the
years, it will be an event(s) that the Fed can NOT control.
Legendary Merrill Lynch
Technical Analyst said the public buys the most at market tops and the least at
the bottom. Here’s recent proof of that
maxim: Net inflows into U.S. equity
funds ballooned to $29.4 billion in the December 15th week. ETF
inflows have totaled $46 billion so far in December (and that follows $81
billion of net buying activity in November).
-->Remember that this is
the same group of investors that were busy redeeming in large numbers at the
March lows!
Main Street vs Wall Street:
It’s
important to note that most Americans have not shared in this year’s stock
market gains. About half of U.S. households do not own stock. Even among those
who do, the wealthiest 10% control about 84% of the total value of U.S. equity
shares, according to research by Ed Wolff, an economist at New York University
who studies the net worth of American families.
As detailed in almost every
news source, millions of Americans are without jobs or income, largely due to
the pandemic restrictions and business shutdowns. The Washington Post reports that they have been
inundated with messages and phone calls from people on the verge of losing
their homes and cars and going hungry this holiday who are stunned that
President Trump and Congress cannot agree on another emergency aid package.
Several broke down crying in phone interviews as they are about to be evicted
from their homes.
In no uncertain terms, the
year 2020 was a BEAR MARKET for humans! But helping people get jobs, have enough food
to eat and not be evicted from their residences isn’t
high on the market’s list of priorities.
It’s liquidity, QE, and ultra-low interest
rates that have ruled the market since March 2009.
This dichotomy between stock
market investors/speculators and the rest of the population has widened income
inequality to unprecedented levels and has created a whole new dimension of
haves and have-nots.
Conclusions:
The Federal Reserve’s efforts
to keep interest rates at unprecedented low levels (such that real interest
rates are negative across the maturity spectrum) squashed the returns available
in fixed-income markets, pushing investors into equities. The central bank
thereby incentivized risk-taking in financial assets (stocks, high yield bonds,
bitcoin, etc.) at a time when risk aversion was not only advised but
required—for everyday activities like simply going out to eat or a movie (you can’t do either of those - even outdoors- in Santa Clara,
CA).
The prevailing belief is that
stocks can’t go down and have somehow morphed into
riskless assets —throwing caution to the wind is the way to play the
market. Haven’t we seen that sort of
attitude before?
End Quotes:
“We are seeing the kind of
craziness that I don’t think has been in existence, certainly not in the U.S.,
since the internet bubble. This is very reminiscent of what went on then,” said
Ben Inker, head of asset allocation at the Boston-based money manager Grantham,
Mayo, Van Otterloo.
"I do think we're at a
moment in time where there's a lot of euphoria. I personally am concerned about
that. I don't think in the long run that's healthy. I
think it will rebalance over time as it always does," said Goldman Sachs
CEO David Solomon.
“The market right now is
clearly foaming at the mouth,” said Charlie McElligott,
a market analyst with Nomura Securities in New York.
“The stock market is euphoric
right now,” said James Angel, a Georgetown University finance professor. “A lot
of people are extrapolating from the recent past and going, ‘Wow, the market’s
gone up a lot and I think it’ll go up more.’ We’ve seen this play out before,
and it doesn’t end well.”
B of A Chief Equity Technical
Strategist Stephen Suttmeier says, “the only thing we
have to fear (in the market) is perhaps the lack of fear itself.” Nonetheless, he’s bullish equities, high yield and emerging markets for
2021.
And the beat goes on…. until
the music stops.
……………………………………………………………………………………………
Good health, stay calm and
safe, persevere under lockdowns and till next time….
The Curmudgeon
ajwdct@gmail.com
Follow
the Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has
been involved in financial markets since 1968 (yes, he cut his teeth on the
1968-1974 bear market), became an SEC Registered Investment Advisor in 1995,
and received the Chartered Financial Analyst designation from AIMR (now CFA
Institute) in 1996. He managed hedged equity and alternative
(non-correlated) investment accounts for clients from 1992-2005.
Victor
Sperandeo is a historian, economist and financial innovator who
has re-invented himself and the companies he's owned
(since 1971) to profit in the ever changing and arcane world of markets,
economies and government policies.
Victor started his Wall Street career in 1966 and began trading for a
living in 1968. As President and CEO of Alpha Financial Technologies LLC,
Sperandeo oversees the firm's research and development platform, which is used
to create innovative solutions for different futures markets, risk parameters
and other factors.
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