Extremes

For at least a couple of years I've come across articles/commentary about how value has under preformed growth so much that it's just a matter of time before this trend reverses in favor of value. But it  hasn't happened and the disparity of growth outperforming value has carried on. We saw last year in September though a brief hiccup where growth got sold off in favor of value because in retrospect you could see that too many actively managed funds were leaning in the same direction. This tends to happen now again wherever there's been a strong trend in place. Even if the fundamentals are still supportive of the trend, if too many people get on board you will get a violent shakeout/rug pull to clear out the excesses before the trend can resume. The problem with value stocks in general is that they simply have had chronically weak fundamentals in general. The largest space in the value sector is financials which have had their margins squeezed due to the flattening yield curve over the past few years. You also have industrial and materials names which have been hampered by lack luster manufacturing and low commodity prices respectively. Meanwhile on the growth side led by tech, you have primarily service type businesses that have been growing steadily year after year, not impacted much by the slowdown in manufacturing and benefiting from low interest rate environment on all parts of the yield curve. The value proponents will say that at some point these trends have got to reverse and so you have to buy now. The problem is that they've been saying this for at least 2 years and have been getting run over in the process. When I studied for the CFA designation they discussed something called chronic inefficiencies which basically means that an asset can be mispriced for a very long time, long enough to make the endeavor of trying to profit from the mispricing fruitless or even worse leading to ruin. Extremes can get to ever further extremes....there's really no limit as to how long or how high a trend can go on for. Just look at bitcoin as an example. Which is why if you are looking to make a bet on a long term trend reversal you need to see evidence of the turn taking place which means you may very will miss out on the first 6 -12 months, but that's OK because the new trend will likely last for several more years. And here's a little secret....when the long term trend does reverse it will be met with heavy skepticism and most of the bottom callers will probably had given up making bottom calls as they were burned so many times. At the bottom of a multi-year downtrend there will be silence, there will be apathy.

Sentiment not favorable for bulls but still not truly frothy

Bears are throwing hissy fits because they can't believe the stock market is ignoring the corona virus. As I said before, this is old news now and even with the latest "jump" in reported cases the stock market simply doesn't give a shit and rightly so in my opinion because ultimately, this is a temporary problem which has nothing to do with underlying economic fundamentals. Any disruptions caused by the virus are not permanent and so once things go back to normal, any kind of production that was delayed will be made up for and there will be a surge in activity. Second of all, the Chinese central bank is stepping up to ensure there are no liquidity crunches. The lessons of 2008 are still imprinted on the brains of the authorities.

I've been repeating here for a long time that the purpose of the stock market is to make fools out of as many men as possible. In order for there to be a meaningful correction you need victims. You need enough people who have weak handed long exposure. The sources of such holders come from retail equity investor/traders, option traders and hedge funds. The less exposure these jokers have the harder it will be for the market to correct. As of now, retail equity investors have only very modestly been getting back into the market as there has been 2 weeks of modest inflows. Option traders have once again flipped back to buying calls hand over fist after getting shaken out a couple weeks ago. Same goes with the hedge funds, they have turned bullish again after getting shaken out a bit a couple of weeks ago. AAII sentiment is once again showing bulls outnumber bears but not by an extreme margin. So, all in all I would say that the market is only ripe for a modest to moderate pullback no greater than 5%. and most likely in the 2-3% range. The other scenario is that we simply keep chugging higher to DOW 30K and NASDAQ 10K without much of a dip. I believe those numbers will get hit at some point this year. It would be piggish to press long bets at this time but also still dangerous to go short aside from the very skillful and nimble hit and run traders. When the market makes a fresh all time high, more often than not it continues to make all time highs and so betting against the market in such case more often than not results in losses.

Keep an eye on the 10 year bond. So long as bond yields remain relatively suppressed, it is bullish for the stock market longer term as it implies underlying pessimism and justification for higher valuations.  The fact that the 10 year is so low right now is another sign that any pullback we do get from here will be modest.

Is Tesla a sign of irrational exuberance in the market?

Tesla was the talk of the town this past week given its meteoric rise. It was due to a combination of heavy short interest combined with a rush of cult like buying from novice investors due to so called  "good earnings news". Yes, the move in Tesla is a bubble but it may not necessarily be ready to burst just yet because from what I can tell, there's still a lot of short interest in the stock and there's no shortage of doubters looking at this big move up as opportunity to bet against Tesla because they know it's a bubble. The problem with these bears is that they often end up being their own worst enemy because they underestimate how long and how far up the run goes on for and end up capitulating which adds fuel to the fire. Tesla right now is very much a cult story stock which has captured the attention of novice retail traders and so until there's some significant bad news to derail it, it will probably go sideways or drift down a bit for a little while until the next "good news" announcement comes out to propel it up again. Only when most people are all in and the weak Tesla bears are cleaned out and too afraid to bet against it, will the bubble be primed to burst. That's my hunch. Some might argue that most people are  already all in. Maybe that's right but from my anecdotes, I'm not so sure about that. I think a lot of people have been wanting to buy but missed out. The other thing that could derail Tesla would be if the stock market in general sells-off hard. All in all, if I had to make a prediction I think there will be one last run up in the stock after perhaps some consolation.

So, does the bubbly action in Tesla represent the general sentiment towards the stock market overall? The answer is no in my view. Just like the moves in weed stocks and bitcoin, the euphoria is isolated i.e. not broad based. Once again, I will point to the fund flows and sentiment indicators. Flows into equity funds are still flat and AAII sentiment was quick to go from mild bullishness to mild bearishness with just a little dip in the market and as the market rebounded to hit new all time highs sentiment remained stubbornly bearish. As I mentioned last time, AAII sentiment only reluctantly turns bullish when the market has a strong move up but is quick to tuck tail and turn bearish with just the modest of declines. That to me says there's still a cautious undertone to this market overall which has bullish contrarian implications. In a bear market you will see the opposite. You will see bullish sentiment rise sharply on rallies and bearish sentiment rise stubbornly on declines.

Don't bet on the downside.

The corona virus sell-off was short lived as I expected. If you're bearish because of this, you better think again because the market has now had enough time to digest and assimilate its impact to the economy and the verdict appears to be that it will not be material in the long run. Meanwhile bonds have rallied quite a bit since then. People are pointing out how the strength in bonds are signalling bearish omens for the stock market.. We heard this argument last year but it turned out to be false because strong bond action (i.e. lower yields) although often a signal of slowing growth in the economy can also be an indicator of rash pessimism which tends to coincide with good ST entry points for the stock market. Just take a look at look at previous times in recent years when bonds had a strong upside move...more often then not it was a point when the stock market was near a ST low.

Slow growth may indeed be what's happening but so long as growth doesn't turn to outright contraction leading to a financial crisis, strong bond action tends to be a positive contrarian indicator for the stock market. Same goes with the oil price. Lower oil prices have generally coincide with good times to buy stocks. Why? Because low oil prices generally associated with rising pessimism about the global economy which provides a contrarian buy signal. Also, low oil prices implies lower inflation pressures and that too is a good thing for stocks in general as it implies low interest rates for longer.

Take a look at history to see when major tops were formed....it took place when bonds were SELLING OFF significantly and oil prices were spiking which implies high optimism, high interest rates and high inflation pressures all of which are bad for the stock market.

The path of least resistance for the stock market appears to be higher for now or at the very least, sideways action. You simply don't get big collapses when conditions are the way the are. If I had a gun to my head I say we are going to see new all time highs sooner rather than later.

Difference between now and Jan 2018

I don't like to get overly fixated on ST sentiment but given the straight line up action of the market lately, I've been watching for extremes which could indicate a turning point of some sorts. AAII sentiment is one of a handful of indicators I look at. Last week I mentioned that it was not showing a bullish enough extreme to suggest a top was in. This week we saw a bull bear ratio climb a bit higher to 1.8. I would say that this is still not a bull extreme but high enough on a stand along basis to make me neutral and avoid chasing the market higher. We continue to see non-existent fund flows into the equity markets overall. The only thing we've been seeing on that front is money getting recycled from mutual funds to ETFs but no new money has been going to equities, it's been going to bonds. This to me is truly amazing. Since December 2018, investors as a whole have been fleeing the equity market. I can't for the life of me envision a bull market peak until dumb money piles back into market en masse and we haven't even begun to see the people get back into the market in ANY way, yet alone en masse! This is a very big feather in the bulls cap long term.

Let's go back to January 2018 which is what a lot of people are comparing this current ramp in the market to. There are huge differences in investor behavior, the media narrative and economic conditions. Back then, high bullishness was clearly evident as indicated by huge equity fund flows, AAII investor sentiment and the general media narrative  signing praise of the "global synchronized growth" that was taking place. This time around, despite the market making all time highs day after day for months, public sentiment is only mildly bullish via AAII and agnostic via fund flows (which carry more weight as it tells you what people are actually doing with money). The only extremes out there are in the options market and hedge fund community which are indeed high enough to fuel a correction as they are weak longs and will bail easily. The media is nowhere close to the "blue skies ahead" narrative of January 2018. Although there is less concern about a recession, the media is nowhere close to being optimistic as they were in early 2018 given the global economy continues to be generally stuck in 2nd gear. So, all in all it would appear that when we do get a correction in the market, it will not be as severe as what we saw in 2018. I would speculate that once this ramp in over we could see a long, drawn out consolidation phase whereby the market doesn't suffer more than a 10% drop from the high. That's just my best guess of course. As usual, my expectations can change as things unfold.

A couple of notable things are the weakness in oil and strength in bonds which could be indicating a further softening economy or at the very least one that is still stuck in 2nd gear. If these concerns gather steam it could lead to a correction that has some staying power. As I type this the market appears to be selling off on fears of the conoravirus spreading. If that's the case I don't think such a correction  would be long lived. 

Bottom line here is that if you're an investor/trader it's a tough spot to be in right now if you have new money to invest.  In  my opinion the market is too extended to go long but there's not enough extremes to go short in a way that you can do so with conviction. If this dip we are seeing gathers steam I don't think it will last more than a day or 2 if it's due to the coronavirus as this is a weak excuse for a sell off. Given the amount of weak longs out there (hedge funds) though, it could end up being a sharp dip but a short lived one... it's a really tough call at this point. 

Relentless ramp

The market has been on a seemingly non-stop run which has even the bulls feeling uncomfortable. I was clearly wrong on expecting a pullback.  Here's my observations on the sentiment front which is fascinating. The option traders/hedgers have fully given up this week so far. The put/call ratio has been very low even when the market had intraday reversals. Usually you would see the put/call ratio perk up when that would happen which would indicate a certain degree of top picking but not this time. Option traders have fully thrown in the towel and have been buying calls relative to puts hand over fist. AAII sentiment has perked up this week with bulls outnumbering bears by 1.5 to 1 ratio. I gotta tell you though, that's not high enough to give a contrarian sell signal given how strong the market has been. It seems like AAII folks have only begrudgingly been turning bullish. Meanwhile equity fund inflows continue to be mind boggling non- existent and that continues to support the LT bullish case. What's it going to take for people to get back into the market?  DOW 50K?  Last time we had a melt up like this was q4 2017 and fund flows were pouring in.

So, we have a weird case here where the market is very overbought, weak longs have been getting in but there's room for even more weak longs to come in as there is plenty of sidelined money that can capitulate and buy in making this market climb relentlessly further still. It's tough to bet on this though because after a parabolic rise typically comes a parabolic fall and if you get caught holding the bag you will get spanked. But you'll also get spanked trying to pick tops in such a market as well which has been the case for many traders as I can tell by the sarcastic, scoffing comments I see on twitter. Best thing to do at this point might be to just watch the show and wait for a better pitch, but I gotta say, benefit of doubt goes to the bulls in the short term until we get more extremes from AAII and the like.

Consensus view is modest optimism for 2020

This is the time of year where I like to read and listen to market forecasts by the "experts" about what's in store for the market in the year to come. From what I gather, I get the sense of modest optimism at best. The expectation is for modest GDP growth and still low bond yields that should see the US 10 year trade in a range from about 1.8% -2.2%. I get the sense that recession fears have dissipated but are not totally gone as there is still lingering worries about trade tensions and political risks. There's also still the strong notion of  the"late cycle" stage of the market we are in and that keeps the herd sensitive to negative events. So although optimism is building, the majority are still watching for that bear market pot to boil and that's contrarian bullish for the market in the LT. In the ST though, there are concerns.

I've seen indicators showing that long exposure from the hedge fund community rapidly increased in December which was the complete opposite of last year when markets were tanking. These clowns are weak longs and I bet were pretty much forced to buy as the market broke out due to FOMO. But mark my words, they are going to bail en masse at some point because deep down, they don't believe in the bull market. That's probably going to cause a 3-5% correction at some point within the first 3 months of the year if I had to guess. In my last post I mentioned that I expected to see the market cool off, but it hasn't yet probably because of continued top picking behavior as evident from the ST trader types and hedgers in the options market. I had thought that maybe they had given up but it turned out it was only for a day. At some point though,  they will give up for good and when they do the market will be ripe for a rug pull to clean out the weak longs that appear to be in the market right now. But this is all ST talk. LT the conditions that I expect to see when the stock market is at the ultimate top will probably look like this:

1. The global economy will appear to be in great shape or at least well on the mend
2. The investing public will have returned en masse as evident by fund flows and other excess such as a large spike in margin debt will be evident. 
3. There will be a popular view that recessions may be a thing of the past and therefore the bull market can continue indefinitely.
4. Stock market bears will be chastised and ridiculed.

We are clearly not at this point yet.