Remember that GameStop and AMC craze at the end of January? It was certainly fun while it lasted, but the market didn’t like it very much. The month ended with the worst performing week since October 2020.
But my, how February has been a different story. This month has been the best month for stocks since the 2020 election, and broad market indexes have consistently hovered around all-time highs. But there are a lot of things to be mindful of and concerned about.
As quoted by Fortune Magazine, Charles Schwab’s chief investment strategist Liz Ann Sonders said, “I continue to think the success of the market, really since early November, has also bred its greatest risk—which is just a very frothy sentiment environment... there’s a lot of complacency, if not just outright euphoria."
She’s not wrong. According to a JP Morgan barometer, global investors are the least fearful they’ve been in two decades. They could also be the most greedy they’ve been in that time frame too. How does JP Morgan figure this?
The investment bank took valuations, positioning, and price momentum and found that all were near their highest levels since the dot-com bubble burst.
And BofA Securities Chief Investment Strategist Michael Hartnett also said that they found in its latest survey of money managers that “[The] only reason to be bearish is…there is no reason to be bearish.”
Earnings season was nothing short of a rousing success to kick off 2021. Over 80% of S&P stocks that have reported earnings have beaten estimates. What's more, earnings are estimated to rise by approximately 24% in 2021 versus the prior (Covid) year.
So what? Well, only 12 years since 1980 have earnings increased by 15% or more, and in all of those years (sans 2018), the market gained an average of 12%. But do the valuations necessarily justify this? Not quite.
Look at the Buffet Indicator, which takes the total US stock market valuation divided by the estimated Gross Domestic Product (GDP) as of February 11, 2021.
According to this chart, the market could be 228% overvalued and 88% higher than the long-term trend line. We also have a higher Buffet Ratio than when the dot-com bubble popped.
Take also the S&P 500. Its Shiller P/E or CAPE ratio (which is a “cyclically adjusted price-to-earnings ratio - basically looking at longer-term, or 10-year, earnings average) of 35.7 is among its highest valuations in history. Its forward P/E ratio is also significantly higher than its historical average.
The small-cap Russell 2000 index has also never traded this high above its 200-day moving average after gaining almost 50% since the end of October. Do the math—that is a bonkers move for 3.5 months.
Couple that with the fact that the tech IPO market is 'nuts.'
Even the Goldman Sachs non-profitable tech index (a basket of non-profitable US-listed companies in innovative industries) tells a similar story. It’s outperformed the S&P 500 and gained almost 250%! Got gains?
What do bond yields have to do with this?
Bonds have seen significant momentum as of late. The 10-year Treasury yield is currently around 1.33%, its highest level since February 2020. The 30-year rate is also at about its 1-year high.
If bond yields are rising, indicating that we could be getting back to normal sooner than we think, why should it be a warning sign for stocks?
It's simple, really. Rising interest rates mean stocks become relatively less attractive. But for growth sectors like tech that have been loving these ultra-low rates, it’s not such a good thing.
Do you know what else rising bond yields mean? Investors expect GDP to heat up for inflation to return.
Rising bond yields could signal that people may want interest rates to rise sooner rather than later. While this is desirable for the cost of goods, it’s not so much for stocks. And we haven’t seen real inflation in a really, really long time.
If interest rates stay too low for too long, which judging from the Fed, could be the case, we could see hikes in prices sooner than we realize by mid-year.
We take our lack of historic inflation for granted. But if this loose monetary policy stays too comfortable for long, beware...
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