Traders are listed on the New York Stock Exchange (NYSE) exchange in New York, USA, February 27, 2020.
Brendan McDermid | Reuters
Despite all the unprecedented events and unforeseen consequences of the past year, the current market conditions are quite close to those seen in mid-February 2020, when stocks peaked just before the Covid crash.
In the six months leading up to its February 19, 2020 peak, the top in the indexes, the S&P 500 had risen 15.8% to a string of new record highs. Today, the index is up 15.9% over the past six months and has been clicking on new records for most of that period.
A lot of the talks in the market are similar too: getting too much of the market to be dominated by some massive growth stocks (the top five S&P stocks were then 20% of the index and are now 22%) and that investor sentiment might have become too complacent.
Then, as now, the S&P was at its 20-year high in terms of valuation, the long-term price / earnings ratio just above 19 and now above 22 – but for those choosing to compare earnings on stocks with the yield on government bonds, is fairly close: 3.7 percentage points then versus 3.3 now.
The spread on high yield bonds has taken a near-perfect round trip over the past year, right at extreme lows, in line with the feeling that generous credit markets are lubricating the economy and markets.
Here’s how this support of stocks and assets from forgiving debt capital markets was featured in this column a year ago this weekend:
Real returns on investment grade corporate bonds are barely above zero. The Chicago Fed National Financial Conditions Index shows that the liquidity background is as loose as this cycle … A clear majority of the stocks in the S&P 500 have a dividend yield of more than 10 years. Treasury bond yields. While there is no perfect relative value indicator, it tends to provide a buffer under the valuation of stocks. “
That is all true today. And that includes feverishly buying a stack of expensive ‘story shares’ that excite younger and more aggressive investors, while the traditionalists get a little nervous.
A year ago, “A cluster of what could be called ‘idiosyncratic speculative growth’ stocks are also doing pretty frisky this year, a sign that investors are aggressively grabbing the next big thing (or maybe just the next quick cash).” Then it was Tesla, Beyond Meat and Virgin Galactic. Today, it’s a few dozen names from GameStop to Canadian cannabis to fuel cells to early-stage fintech apps.
What is different now?
So the echoes are pretty clear as this anniversary approaches. However, the differences are many, important and make today’s market more dynamic in both beneficial and – potentially, ultimately – dangerous ways.
Let’s be clear that noticing the similar market set-up is not even remotely a repeat of the market collapse and economic catastrophe that began to unfold in late February last year. The spread of the coronavirus was a real external shock, the forced global economic shutdown a first, the five-week free fall of 35% unprecedented.
Which brings us to some of the more crucial differences between now and a year ago. The collapse turned the clock back on the economic cycle and policy positions. From 2019 to 2020, Wall Street was embroiled in an end-of-cycle vigil, with the economy near the employment peak, the Treasury yield curve flat, corporate profit margins near the peak and the expected profit.
The Fed was on indefinite hold in February 2020 with short-term interest rates of 1.5-1.75%, but a significant minority of Fed officials predicted an interest rate hike in 2021.
The sudden recession and earnings collapse triggered about $ 5 trillion in more likely deficit-funded fiscal aid, and made the Fed cap easy for some time to come, with the intention of waiting for a return to full employment and a sustained increase in inflation before any tightening movements.
So yes, valuations are now higher and investor expectations can become unrealistic.
But Corporate America has been refinancing itself for years at invitingly low interest rates against a Fed backstop, earnings will be back above their previous peak this year, the government is keen to keep the economy warm, and (arguably) policymakers have just carried out a repeatable process. circuit a recession.
Smaller investors come in
Another way things have changed in a year is the heady rush of smaller investors in the market, who felt invincible after surviving the crash and rebounding nearly 80% in the S&P 500.
Investors’ willingness to take full advantage of leveraged upside betting in the form of call options in unprecedented volumes and the immediate mark-up of new IPOs such as DoorDash, Snowflake and AirBNB for tens of billions of market value at sky-high revenue multiples shows a new, more aggressive and more risk-tolerant ethos on the tape.
Some of this energy started flowing a year ago, but it had not gained nearly as much momentum or taken on a viral character. The Russell Micro-Cap Index is up 65% in 3 ½ months. The amount of money has increased fivefold in the same period. In fact, the total trading volume increases as the indexes pick up – the reverse of the typical pattern and harking back to a similar pattern from the late 1990s. Stock inflows in the past week have set a new record.
Social media stamps returned GameStop stock from $ 12 to $ 400 to $ 52 in the past two months, then brought Tilray back from $ 18 to $ 63 to $ 29 within two weeks. Meanwhile, volumes are in fixed S&P 500 ETFs have fallen to lows in several years, apparently not spicy enough for the fringe buyer.
That entire litany describing the untamed animal spirits running through Wall Street says both that this is a powerful and well-sponsored bull market and that the risks of a wild overrun are increasing. On the other hand, everyone knows they are building and have been sounding the alarm for a while.
Bank of America indicator is approaching sales territory
Does the fact that sub-sectors of Reddit stocks and fashionable green energy games are exaggerated and then punctured without undermining the big-cap indexes mean that they are not dangerous? Or is the fact that persistent buying in small short-squeeze stocks for a few days late last month caused a rapid 4% S&P 500 spill, a warning that the erratic tremors cannot always be safely dissipated by the base of the market?
A year ago, Bank of America global strategist Michael Hartnett told investors to keep playing risky assets “until investors become more clearly ‘euphoric,’ which he says will mark the moment of ‘peak positioning and peak liquidity.'” Hartnett maintains that. The same vigil now, its Bull & Bear indicator is correctly keeping investors engaged but is reaching a rebellious sell-off threshold (which preceded corrections in the past and was last hit in early 2018).
All of this goes back to the thought aired here in early January that 2021 presents as a new mix of 2010 and 1999 – the first full year of a new bull market with long-acting recovery forces mixed with the last year of a powerful bull. market that shot through each upward target creating levels of excess that took a few years to clear up.
Interestingly, however, the core of the market being captured by the S&P 500 is metabolizing this mixture with a rather steady and well-behaved – you might even say boring – upward trend. At least for now.
Starting next week, Mike Santoli’s columns will only be available on The Washington City Times Pro