Market Musings 19/12/20: How close to Euphoria are we?

19th Dec '20 by Edmund Shing

23 comments 3346 reads

How close to Euphoria are we?

Summary:

Sentiment seems to be extremely bullish. But when everyone is already bullish, who is left to buy?
IPO index suggests that euphoria is creeping into portions of the stock market.
We may be hearing echoes of the 2000 TMT bubble and bust
In contrast, the commodity cycle looks finally to have broken out of its long-term bear trend

Is Extreme Greed and IPO mania a warning sign?

While the Santa rally suggests that the year-end should be bullish for stocks, I am becoming increasingly concerned by the pervasive optimism everywhere concerning stocks.

One illustration of this bullish consensus can be seen in the AAII sentiment survey of American individual investors. The chart below measures the difference between the number of bullish and bearish investors, and has historically been a good contrarian indicator.

That is to say, a high net bullish reading (as we have today) suggests that the stock market could be due a correction, as we saw at the beginning of 2018, for example.

AAII Bull-Bear sentiment spread shows extreme bullishness

cwmO_10dDYrKyqioxWC0IXnT9Q_b9jMIA2Afj29NLN1JAyAEHVgmagw16_DDApj_Ug-_beUmQC5Ath5qXKr1J3v_IwsYaH3ivzMPOaRBfJ6_jMjP8oIhvoawfQ-4qwCMzH1eS3dt

Source: ycharts.com

Another sign of the froth in stock markets is the huge performance of the IPO ETF, which measures the performance of new entrants to the US stock market.

IPO ETF has gained over 100% this year

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Source: tradingview.com

It is likely that this IPO mania is being powered largely by US retail investors, who tend to be very momentum driven and generally buy at the top, and sell at the bottom…

Echoes of 2000?

Those of you who have been investing for over 20 years might see the parallels between today’s situation and the 1999-2000 Tech-Media-Telecom (TMT) bubble and subsequent bust.

The mega-cap tech momentum around the FANG stocks (Facebook, Apple, Amazon etc.) continues unabated, with the NYSE FANG+ index hitting yet new highs for the year.

US FANG group of tech stocks surges to new highs

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Source: tradingview.com

Back 20 years ago, the Nasdaq Composite index more than tripled from its late 1998 low to its peak of over 5000 in March 2000, before then imploding in spectacular fashion as the over-investment in areas such as fibre optic cables did not find sufficient demand.

Nasdaq composite index soared to 2000, but then suffered…

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Rusty2

19th Dec '20

That maybe so but if the US market corrects then no doubt so will ours. Even 30 years ago the US markets seem overvalued compared to ours.

Do you know when was the last time the U.K. markets were more expensive than the US?

One issue is weighted indexes, our large companies just are not growing as fast as the US ones, you look at our large companies compared the US ones. We have no large technology companies, they all get taken over as they look cheap.

I think Brexit is part of the issue but the FTSE100 has hardly grown in 20 years.

UK_Investor_8888

When The US bubble bursts, how badly does it affect us?

I don't do US, crypto, commodities or currencies.

Quite badly and the US markets tend to recover quicker.

I have some US shares but I sold out too early on some due to valuations. Some valuations are justified because of strong growth. But some do look crazy.

Problem is interest rates are so low, seems more people are investing in the markets. It’s hard to even get 1% savings rates, I can’t remember rates being this low.

William K

When Wall St sneezes the FTSE gets pneumonia.

The Ox 2906

A commodity bull market would be good for the FTSE with the proliferation of Oil and Commodity stocks just as the bull market in Techs has been bad for the FTSE since there are so few and any get taken over before full growth. Thanks Edward for a thought provoking piece.

jwebster

20th Dec '20

"Sentiment seems to be extremely bullish. But when everyone is already bullish, who is left to buy?"

Money rotates, USD is dropping, investors shift from SPX to EM markets on global reflation expectations. A lower dollar is good for EM as well. Amazingly the FANGs have turned into bond proxies, safe quasi-monopoles with low (no) debt, strong cash flow and high liquidity, thus a safe haven for institutional cash. As the Fed buys Treasuries institutions are crowded out and pushed into the waiting FANGs.

I recall the SPX climb in recent years as a hated rally with PE ratios steadily expanding and the index rose faster than underlying earnings. There were corrections on the way, two notable ones when China looked wobbly on their currency management and the other when the Fed sparked a taper tantrum.

Global GDP is around $83T with growth normally around 3.5% which is 2.8T each year. Much of that growth actually comes from China. In turn, the US Fed still fundamentally controls global interest rates. So, these are two big event centres which are large enough to derail the momentum behind global growth. Can ignore localised issues like Brexit which are not relevant on at the global level. Scenarios:

1. US Fed raises interest rates in response to uncontrolled inflation, resetting the discount rate for valuing all assets globally. This would cause a severe crash across bonds, stocks and property, as their current capital values rely totally on a low discount rate.

Is this likely? Who knows. The Fed seems emboldened given the 2010+ QE didn't slosh into the real economy, globalisation kept a lid on goods inflation and the Japan canary is still chirping in the coal mine, albeit covered in soot. This time QE has gone further with commercial loan support and furlong cash. Perhaps we might see a reaction next year. Corporate and personal savings on deposits are at extreme highs, which is new. There is a lot of cash waiting to be spent. 2021 H2 might be that surprise. The Fed would be very late to the party not wanting to go down in history as the recession agent, but if inflation did get traction the bond market would quake which would spill over into stocks.

2. China stumbles its experiment with introducing moral hazard into the state-owned enterprise bond market.

You may have noticed some major bond repayment failures recently and the partial freezing of credit markets in China. This is the CCP trying to wean investors off implicit government guarantees. They are right to do this, but the CCP has form with missteps as it experiments in real time with central planning capitalism. I find this an interesting scenario as it would catch many by surprise, it’s not priced in. I’m reading all news on this carefully as it’s just the sort of below the radar event which catches markets.

Outside of a major event, markets could just keep climbing the wall of worry. Who is buying stocks at these levels? Well, the Fed is through buying Treasuries pushing institutions into alternative financial assets and the Covid cash is piled up in bank accounts ready for spending. 2021 may see a spurge of cash driving a push into assets. On the down-side any change in sentiment on inflation, interest rates or the China-led reflation story will mean sharp corrections, given nose-bleed valuations, at least in the US. UK stocks looks cheap, although I weight to miners and small caps myself.

Let's see!

Good post jwebster. Thanks. In summary, whilst interest rates are at rock bottom low, retail investors will buy equities as there is nowhere else to put their money. Institutional investors will have to buy at prevailing prices as many of them aren't allowed to sit on cash. This will drive up the indices until the next black swan and we'll relive dot.com of 2000. I love the concept of FANG stocks being the new Treasury bonds. Spot on.

Are we witnessing irrational exuberance, or are there a lot of smart investors with well primed exit strategies?

betjeman

Dividing the total US Mkt Cap of quoted stocks by US GDP is an interesting mathematical calculation but tells you very little about whether the US market is good value or not............

main problem/issue with this simplistic calculation is that you need to know how much of the trade undertaken by these quoted businesses is non-domestic and how it has changed over time e.g. how much of the Fangs trade is non-domestic both today and historically and therefore measuring their value against US GDP alone is a false calculation.

Logical David

Hi jwebster, as you correctly mention there are problems with China's bond market and I understand it is a $15 trillion problem, possibly a ticking time bomb problem due to excess conditions which are colliding with increasing default rates. As the saying goes, "when the USA sneezes, the UK catches a cold".

Will the Chinese bond problem combined with the overpriced USA stock market be the catalyst for a tsumani correction during 2021??

Macro

Edmund,

Your question; "How close to euphoria are we?", is an interesting one.

Stockopedia does not stray into the area of Market Timing, prefering to stick to a strict ranking system. Other systems to attempt to support market timing although they usually stick to indicators based upon the past rather than any predictions of the future.

One private investor that I am a great fan of is a gentleman by the name of Jeffrey Scott. He performs a weekly top down market analysis in the form of a video that he posts onto Youtube and Dropbox: https://www.youtube.com/c/JASC...

Running to about 45mins-1hr his weekly analysis focussed on the USA market. His review has become a standard part of my prep for the week ahead. ... I am very envious of the data and toolset support that exists for the USA market. Nevertheless I think his weekly review is very worthwhile - even for UK based investors.

His summary for this weekend might be: "Extended, but not overly so".

Phuntt

Similarly Edmund, my weekly process always involves listening to Guy Monson from Sarasins. Sarasins are an old money bank investing generally for the super wealthy. He gives a great breakdown on macro trends and effects on asset classes on a weekly basis - always worth listening to at least to understand where the smart money is - right now (and for last few months) they remain overweight on stocks - note this is a very general breakdown not by sector or region.
I think there is another correction coming, probably started by a scare in the US next year but not yet.

21st Dec '20

"Will the Chinese bond problem combined with the overpriced USA stock market be the catalyst for a tsunami correction during 2021??"

When China stumbled in early 2016 SPX sold off 14% in a couple of weeks then rebounded when the CCP stepped back in, which they will always do. They can't bear the social unrest from a recession. Likewise, in the USA the Fed is now strapped to the political engine of keeping voters onside. Two sides of the same coin, piling up future liabilities.

As long as the CCP keeps pumping China's GDP growth engine and the Fed, in conjunction with Federal spending, keeps the liquidity flowing and interest rates on the floor, stocks up.

As I write I see US lawmakers have agreed a $900B stimulus package. And that's following the $2.2T package in march. For comparison US GDP in 2019 was around $21T so fairly substantial numbers.

Eventually, this path will run out of road, like all cycles. In the meantime I ride the liquidity waves and store returns away in alternative assets (not stocks). It could last a long time, who knows. We just climbed out of the Covid recession and look what happened there. Such a shock would normally have exited over-indebted companies with weak balances sheets, but they have been saved by the government.

Bloomberg have pointed out the spread on earnings yield on US stocks over Treasuries is still reasonable, so stocks are not in a bubble yet. This brings us back to the same point, stocks are held up by QE liquidity and low rates. What could crack that? No Fed Chair or US President would willingly increase rates and create a recession. So it has to be something outside of their control. Perhaps after a few more years of this, the unthinkable happens and a global glut of USD make people lose faith in its value and forces investors to flee to non-USD assets. That would do it as interest rates would rise as bond values fall, the Fed would lose control over rates and investors would head for the hills.

The alternative is MMT where QE keeps on going and is used to fund perpetual fiscal deficits and support stock prices. E.g. Japan where the BOJ buys stock ETFs directly.

Well, no-one will ring the bell for us, so in my mind I think that while the FED and CCP want low rates and growth, stocks up for now. In the long run, I distrust the USD, Pound and US tech stocks to hold their value, don't park long term assets here, just short term trading.

Thanks for the link, Macro. Most of my trading is done with US stocks - mainly ETFs - so I found the sector analysis particularly helpful.

Hi betjeman, it all depends on how simple or how complicated you want the problem to be. I prefer to work on the simple model because it is easier to understand. One of my sayings is: "If you don't understand it, don't buy it".

This not only goes for things like cryptocurrencies, commodities, etc but overly complicated technology and processes. I understand this is one of the reasons why Warren Buffett is sitting on a cash pile in the region of $140 billion because the above equation is clearly stating that the USA market is currently overpriced.

Wilconz,

So if you use ETFs and US stocks then you might like a gentleman by the name of Arthur Hill.

Arthur is a Texan who now lives in Belgium. Quite how he ended up in Belgium I am not sure - might have been NATO, or the beer, or the lack of CGT, or most probably a woman!

Anyway, Stockcharts used to have in-house market comentators but their model changed and they all became freelancers. That forced their commentators to start their own companies - and Arthur's is 'Trend Investor Pro': https://trendinvestorpro.com/ & https://www.youtube.com/channe... & https://twitter.com/ArthurHill but he still contributes via the Stockcharts Youtube channel, too: https://www.youtube.com/user/s...

His approach is to trend follow after determining overall market direction through ETFs of the major indicies and sectors. And he has written a book on the subject, too: https://www.amazon.co.uk/Defin...

If you like to learn about TA generally, Arthur also wrote the majority of the material on the Stockcharts 'Chartschool' area: https://school.stockcharts.com...

So, he is a teacher, commentator and an investor. One who takes a very sensible approach. 'Steady'.

Thanks 'Phuntt',

I was not aware of Sarasins - and have now added them to my list.

The sources I tend to use most often are:

- The JP Morgan Quarterly Global Asset Allocation views: https://am.jpmorgan.com/us/en/...

- The Blackrock Global Weely Commentary: https://www.blackrock.com/us/i...

- The Reuters G20 Poll of Growth & Inflation: https://fingfx.thomsonreuters....

- The 'Guru Focus' Market Valuations and Projections: https://www.gurufocus.com/glob...

- Start Capital Market Valuations: https://www.starcapital.de/en/...

And of course I pay attention to the Hedgeye views via Youtube and free content - https://www.youtube.com/channe...

The Phoenix

Very good would you mind directing me to where you can view the list of most recent ramblings.

Regards Andy

Mnomis

22nd Dec '20

Many thanks for sharing!

intuitive6191

Lyn Alden sends a six weekly email which is usually interesting comment supported by copious use of FRED charts.

I dont have a lot of time to follow the US in great detail - so this helps me keep in touch.

https://www.lynalden.com

As a general comment - I dont know how long the bull market will run in the US but I see that a new round of cheques will be sent to US citizens as part of the $900 billion deal. I think it's fair to assume that this will fund a new tranche of retail investors via Robin Hood accounts.

23rd Dec '20

Thanks Macro. I'll check those out. At present I start my day with daily newsletters from Investopedia and continue my research on the basis of their market summaries. Their top down approach I find cuts risks significantly, as does diversification through ETFs.

Market Musings 19/12/20: How close to Euphoria are we?

How close to Euphoria are we?

Summary:

Is Extreme Greed and IPO mania a warning sign?

Echoes of 2000?

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About the Author

Edmund Shing

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