Traders work on the trading floor of the New York Stock Exchange.
Wall Street didn’t need a warm up to get into 2021.
Investors are pliable, money is loose and the market is already running hot, fueled by two independent sources of energy: the case of reflation and the chase for disturbances.
The tape looks near a point where the only plausible next step is a cool down or overheat phase that threatens to burn the unwary on the road.
Neither of these would mean a final market summit in the least. This is a bull market, after all, which is well supported by generous monetary policy, more fiscal aid along the way, and lots of latent purchasing power from households and big corporations when public health allows.
It’s more about short-term risk / reward tradeoffs, whether the band can regroup to keep going (as it has done a couple of times since the summer) and whether the speculative pressures at more dangerous extremes increases.
The course of the broad market has grown somewhat compared to its longer-term trend. The S&P 500 has broken its upper Bollinger Band, a trend indicator based on price and volatility.
As the graph shows, strong rallies can stay overbought and ride the top track for a while. However, if you go beyond that limit (like in late August), traders should typically watch for a reversal in the downside mean.
S & P 500 with Bollinger bands
The winds of reflation are also blowing strong now, carrying cyclical stocks and government bond yields higher at a steep angle. The post-crisis recovery momentum, trillions of trillions more stimuli in the system promised by the new president, a surge in consumer savings, and revived corporate earnings forecasts have forced a quick re-evaluation of inflation expectations (up to 2% in the next five years) as well global commodity prices.
All of these things rise from depressive levels, but might some take a breather soon? The Russell 2000 Small Cap Index is up 35% in ten weeks and the regional banking sector is up 42% over the same period.
The performance of high beta stocks (more volatile and cyclical) versus more defensive, low volatility stocks is at a decade high.
Invesco High Beta ETF vs. Invesco Low Volatility ETF
The 10-year government bond yield rose over 1% last week to hit 1.1%. This is catching up with other market-based reflation indicators as bond traders, under the full democratic control of DC, have drawn more debt-financed tax aid.
Returns remain in some sort of sweet spot even after this jump, confirming the case for better growth and brisker inflation, but not yet high enough to contain corporate and mortgage borrowers or to undercut the strong valuations of stocks.
Given “valuations that are quick to lean on old extremes of 2000,” as Doug Ramsey of the Leuthold Group puts it, it is unclear at what level of return stocks would lose the fig leaf rationalization to value appropriately given the lows but it’s probably a good deal higher than the returns are now.
The eager risk taking in seeking a quick reward is hard to deny. The increase in equity fund inflows over the past two months as a percentage of total fund assets was the second highest in a decade, according to Deutsche Bank. Bitcoin has doubled in the month since it hit a new high for the first time since 2017.
The AAII retail investor survey last week found twice as many bulls as bears, an extreme offset for this survey. The volume of call options for individual stocks – leveraged bets on short-term upward moves – has fallen to last summer’s record high.
Insurance app upstart Lemonade is up 77% in three weeks, thanks to the general craze for financial technology games. Lender SoFi announced last week that it would join forces in a special purpose vehicle (SPAC), and SPAC shares rose 50%.
Fintech companies waiting to go public soon include smartphone broker Robinhood and crypto exchange Coinbase, two gatekeepers of the youthful zeitgeist. A new fintech SPAC was floated on Friday under the ticker symbol LMAO.
These are all vehicles that are used in tracking down incidents. Along with old banks and dirty oil drills and messy mining companies that have been hit by the reflation trade, many dozen of these trending stocks – long-term bets on world-saving themes – are bringing warmth to this market.
Tesla’s unparalleled rating
The enthusiasm is not necessarily unfounded. Amazon stocks have looked expensive at every step to a $ 2.2 trillion market value, certainly compared to the older retailers who have since become largely insignificant. So who can confidently say that PayPal and Square, which together are now roughly the same value as JP Morgan near $ 400 billion, are wrong?
And then there is Tesla. A unique example of mass enthusiasm that is accumulating at an unprecedented rate to hundreds of billions in market values. The valuation – I know who cares, but still – is now roughly 90x the cash flow of 2021. Amazon hasn’t traded more than 30 times in the last 15 years. Last week, two analysts capitulated and withdrew their cautious ratings on Tesla stock. They apologized embarrassed for not misunderstanding the business but misunderstanding the emotional state of the market.
With a fully diluted market cap of nearly $ 1 trillion, Tesla’s valuation has surpassed anything seen in the business by such a distance that it has become almost an abstraction – an idea like Bitcoin of something that is causing the fuss has forced its believers to a size and position where it simply has to create the future.
And the privileged access to cheap capital that the share price surge (up 25% last week and 800% last year) has given the company gives it a better chance – albeit far from a certain – of manifesting the dreams from its founder and his followers.
Bank of America strategist Michael Hartnett sees a market of “foamy prices, greedy positioning, inflationary and desperate policymakers”. He has suggested that the “all-in” positioning should be achieved by February through March and advises investors to “sell” the vaccine once it is widely available. “We’ll know if it’s a bubble in the end [of the first quarter], “he adds.
Again, all of this does not mean that this market is acutely fragile or largely irrational. It’s hard to find a huge bug in FAANG stocks, which have 30x free cash flow, for example (much cheaper than Microsoft in 2000).
It is more of a comment on the nature of the market and a suggestion that we may be in the manic, exuberant, less disciplined part of a bull market. In other words, the fun part where some of the fun comes from hinting at danger.