Dangerous Market Redux
In November of 2019, I penned an article in this section of cyberspace where I suggested the equity markets were the most dangerous in the history of history. A significant market top occurred three months later. Where are we today?
Shortest Bear Market in History?
There are some who’ve declared the February – March action as the shortest bear market in history. A decline such as this convinces investors that the market’s action is merely a pullback necessary for the continuation of the bull. It’s not uncommon to see a surge of investment activity during the decline. There were many new entrants to the world of equity investing during the market’s most recent time of woe.
In fact, the trading app, Robinhood, added millions of accounts in the first part of the year and outpaced all publicly traded brokerage houses in the month of June when measuring Daily Average Revenue Trades (DART). Don’t feel badly for other brokerage houses. TD Ameritrade (AMTD) did quite well with a fiscal third quarter that exceeded their own estimates. Are we now in a bull market?
Most Dangerous Time
The most dangerous time for a market is what occurs during the initial retracement, or the move after the market’s first decline. As noted earlier, instead of a mad rush for the exits, there was a mad rush into the theater (Yes, I realize theaters are closed now, so play along with the metaphor!) Speculation runs rampant and institutional complacency may reign. Frequently, there are non-confirmations with other markets and a narrow focus on a select list of stocks.
For example, the new highs in the S&P 500 and Nasdaq are unconfirmed by the Dow Jones Industrial Average. Moreover, the Russell 2000 index made its high over two years ago. There’s intense interest in a thinning list of tech stocks that has propelled the S&P higher. This list includes Facebook (FB), Alphabet (GOOG), Microsoft (MSFT), Apple (NASDAQ:AAPL), and Amazon (AMZN). Add Tesla (TSLA) to the list of stocks receiving great interest. It seems almost folly when I noted the degree of Tesla’s overvaluation in February. At that time its market cap was a “mere” $100 billion. It’s now nearly four times that figure. Its Price-to-Book ratio was 17 compared to 42 now.
Both the Nasdaq and the NYSE advance/decline ratios have continually weakened throughout the course of the market’s advance since late March. Thus, it seems the criteria outlining the retracement’s danger is in place. In addition, CBOE put/call data is at its lowest level in 16 years, which includes the period before the Great Recession top of 2007.
Correlation Among Asset Classes
This section will describe a visual correlation as opposed to a statistical one. How did the various asset classes behave during the stock market’s swoon in February and March?
What follows is a series of charts (courtesy of Yahoo Finance) showing how various asset classes behaved during this period. The red arrow pointing down represents the stock market’s February top and the green arrow pointing up represents the March bottom.
The Euro made a low (US Dollar high) coincident with the stock market before experiencing a spike high in the middle of the equity swoon. The Euro made another low very close to the stock market bottom and has taken off from there.
Treasury Bond yields were already headed lower (prices higher). Yields bottomed in early March before spiking a couple of weeks later. Yields have moved down and appearing to be trending up again, albeit slowly.
The purpose of the charts was not just to illustrate correlation but also to illustrate why liquidity matters. During times of distress and panic, that rush into the theaters I noted earlier reverses flow and everyone wants to head for the exits. That’s what we witnessed in February and March. But to many, particularly the new entrants, the market healed, if for no other reason, courtesy of our central bank wizards who ignited waning optimism.
In a wide ranging interview on the Real Investment Show, I outlined how the central banks will respond, at least economically, when the next downturn arrives.
The Great Reset
We’re still in the middle of the omnibubble, albeit a reinflated one. The omnibubble means many asset classes are more correlated than before. As such, the end of the stock market’s run will mean a commensurate pullback for other asset classes as well. This means we should witness a top in the gold and silver market, a high in the Euro, and a high in Bitcoin as traders and investors seek liquidity. I believe the high in Treasury Bonds is in the rear view mirror with higher yields in our future.
Even if you do not agree with my thesis, it’s difficult to argue about forthcoming volatility. In the last couple of weeks, there’s been a divergence with the VIX and the stock market. Normally a rising stock market means a declining VIX. This relationship has been changing as of late. Investors can look at VIXY (Pro Shares short-term VIX ETF) to profit from volatility.
Disclosure: I am/we are long VIXY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.