As Wall Street searches for worries, stocks keep climbing.
How’s your portfolio? Mine is great! Yours too? But of course! Risk assets just had a blowout month. Bitcoin was up 40% and the small-cap Russell 2000 index rose 18%, its best month ever. The S&P 500 returned 11%, its best November since 1950, and it and other major indexes keep setting new highs. Wall Street houses are pushing up the consensus S&P target for next year, with estimates at last check ranging from 4,000 to 4,300. Some view the market as overbought and are worried a strong November will steal from December, typically the strongest month of the year for performance and the percentage of positive returns. The runup has made equity risk premia—returns beyond risk-free trades—less compelling as the easy money has been made. But it’s hard to bid against all this momentum—and historical data suggest investors shouldn’t. December began with 93% of S&P stocks trading above their respective 200-day average, a top-decile reading. Strategas Research shares that the greatest likelihood for a positive 12-month forward return has come when stocks are bunched in this top decile. There’s “overbought,” it says, and then there’s “really overbought.’’ The latter tends to be quite bullish and that’s where we are. A falling VIX, strong forward earnings (Deutsche Bank put a $194 earnings-per-share target on the S&P for 2021, 38% above what it expects this year) and seasonality also are in stocks’ corner. Whenever it’s risen 10-15% through November (the S&P was up 11% this year), stocks have seen a December rally 100% of the time. Are you going to bet against this?
Breadth has broadened significantly, with new 52-week highs on the NYSE jumping above the 350 level, a clear indicator of participation. The NYSE advance/decline line made an all-time high last week. A lot of this has to do with the recent rotation from tech and defensives into cyclical and small-cap stocks, which after trailing for years, have led since September. Growth stocks have underperformed value by 900 basis points the past three months, the fastest and largest underperformance in 14 years. Of seven prior reversals of significant underperformance by the large-cap equal-weighted index vs. the tech-heavy market-cap-weight returns since 1927, six produced double-digit annualized returns the ensuing 24 months, both for large and small-cap stocks. The lone outlier was the February 2000 dot-com bubble peak. (Are we in a bubble now?) This rally has been fed on expectations successful vaccines will lead to an unprecedented synchronized global rebound, with the lagged impacts of unprecedented monetary stimulus and another round or two of fiscal stimulus adding more punch. (Perhaps not a bubble.) Despite some recent softening and worries the Covid spike could slow the recovery in early winter (more below), a lot of the macro data remains solid if not robust (more below). And while net equity fund and ETF purchases have turned positive of late, a turnaround from most of the year when investors flocked to bonds, $4.3 trillion stands on the sidelines, ready to come in.
So, what could we worry about? Possibly the Jan. 5 runoff elections in Georgia. Recent polls are trending toward the Democrats, who if they win could have unchecked power to raise taxes, hike spending, provide a universal basic income, nationalize health care, implement their Green New Deal and so on. Even if there’s an eventual Democratic sweep, the Dems’ margins in both chambers will be razor thin. The market reasons that most progressive polices will thus be off the table. Excessive optimism is Wall Street’s estimation of the biggest current threat. Investors Intelligence and AAII readings, the 4-Week CBOE equity put/call ratio, the CNN Fear/Greed gauge and Goldman Sachs sentiment are all at frothy levels. Valuations argue for trepidation, too. P/E multiples exceeding 20x tend to see poor returns 12 months out—the current S&P P/E is above 25x—and Shiller’s 10-year P/E ratio of prices to average earnings over the past 10 years (CAPE) is at its highest-ever level outside of the 2000 bubble. Of course, P/E is high in part because bond yields are near multi-century lows—63% of S&P members yield more than the 10-year Treasury. (If there’s a bubble anywhere ….) The market deserves a pullback—seasonality is about to turn and 3-month forward returns typically peak in the first three months of a new presidential cycle. All told, it’s dangerous to be a bear. Wall Street has decided to worry about sentiment. Sentiment, schentiment. Next year, it will be inflation. And they will be way too early.
- Manufacturing in a ‘V’ The ISM gauge slipped in November but remained close to its 2-year high, with 16 of 18 industries reporting growth, the highest share since mid-2018. Markit’s separate survey jumped more than 3 points to its highest level since September 2014. Factory orders rose a sixth straight month and more than expected, led by an acceleration in core goods that are indicative of business investment.
- Services in a ‘V’ Markit’s gauge of services activity in the U.S. rose in November to its highest level in four years, with new orders growing at their fastest pace in two years and services employment rising at its quickest rate since 2009. ISM’s separate non-manufacturing survey wasn’t as robust, dipping to a 6-month low that matched consensus. But only four of 18 industries reported contraction.
- A global synchronous recovery for 2021 Global manufacturing activity accelerated in November on broad-based improvement—74% of countries in the Markit index were in expansion territory, helping lift the employment component above 50 for the first time this year. Despite spiking Covid cases, the future output component rose above 65, reflecting strong expectations.
- Jobs will determine the ultimate shape of this recovery Led by a 100K drop in government jobs, November nonfarm payroll growth surprised, coming in at 245K, nearly half the consensus and the smallest gain since the jobs recovery began in May. While the unemployment rate fell to 6.7%, it was primarily due to the exodus of more than 400,000 labor-market participants who couldn’t find work. The market chose to accentuate the positive, figuring the disappointing report raises odds of a stimulus deal before year-end.
- Beige Book’s warning signs The Fed’s periodic report showed activity slowing across regions, with hiring and wage growth softening. Several districts said they are vulnerable to the latest Covid surge and expect job losses over the winter months.
- Housing catches its breath Pending home sales edged down 1.1% in October, its second straight decline. A shortage of inventory appeared to curtail buying, an issue that’s seen new home sales soften after soaring over the summer. Pending sales were still 20% higher year-over-year (y/y), with all four regions posting double-digit gains.
A quite volatile way to diversify, IMO Leuthold (among other Wall Street firms) explores whether bitcoin is the answer for an investor concerned that an all-equity portfolio is “far too volatile” to sleep well at night. On the one hand, since 2018, the standard deviation of gold and bonds relative to the stock market has been about 33% less and 80% less, respectively, while it’s been 3.5 times more for bitcoin! However, for every 1% increase in bitcoin, the S&P has changed by a minuscule 0.03%, making bitcoin uncommonly “independent” relative to stocks and other investment alternatives, a very desirable attribute in a balanced portfolio.
Who couldn’t use a few laughs? Research analyst Paul Sankey shares: What is the most dangerous part of a car? The nut holding the steering wheel. … Who is this Pavlov guy? I cannot place him. But his name rings a bell.
I’ve got three trees in my house Stuck at home, many appear to be turning to holiday decorations to brighten their house. Evercore ISI’s proprietary Christmas tree sales survey shows 2020 sales off to a phenomenal start—up 29% y/y so far, with really big trees favored.