Market Commentary, KR DOCU & ULTA Earnings, The $ Is Breaking Down
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Today (Thursday) was a little more interesting than Wednesday, with a nasty last half hour selloff, but the end result was the same: little change in price on low volume. The major indexes performed as follows: S&P -0.06% NASDAQ +0.23% Russell +0.58%. Like Wednesday, volume in the main ETFs that track these indexes (SPY, QQQ and IWM) was anemic. No reason Friday should be any different.
However, there were a number of notable earnings reports today (Thursday)
The country’s largest supermarket chain, Kroger (KR, $24 billion market cap), reported before the open. Top Gun is long shares of KR and the numbers looked fine to me with comps +10.9% and Adjusted EPS +51% to 71 cents. However, shares finished the day -4.37% on 3x average volume as investors are concerned about the implications for their business of a reopening.
In the afternoon, Docusign (DOCU, $48 billion market cap) and Ulta Beauty (ULTA, $16 billion market cap) reported. DOCU reported Revenue +53% to $383 million and 22 cents Adjusted EPS. The problem here, as with so much Tech, is extreme valuation. DOCU guided full year revenue to $1.426 billion to $1.430 billion. That means shares are trading at 33x current year revenue: 33x earnings is expensive; I don’t know what to say about 33x revenue!
ULTA reported an underwhelming quarter with comps -8.9% and Adjusted EPS -26% to $1.64. I have no idea why shares were trading near all-time highs heading into the report but last time I checked the after hours they were off about 4%.
On Wednesday, I talked about “The Economics of the $ Breakdown”. It’s important to understand that so that you know why I, and so many other investors, are following the $ so closely. Here, I simply want to point out that the $ Index has broken down below its 2020 support at 92 and now appears headed to the 2018 lows ~88.5 (Chart Source: Grant Hawkridge Tweet, 12/3, 9:05am PST).
Chris Kimble stepped back and looked at a monthly chart of the $ going back to 1985. If 88.5 doesn’t hold, I don’t see much support all the way back down to the all-time lows ~72 from 2008. If this happens, expect the magnitude of the three consequences I wrote about in “The Economics of the $ Breakdown” to be extreme. The first two – rising interest rates and real economy inflation – would likely wreck and destabilize our highly indebted, import dependent economy.
Nothing Doing Wednesday, December’s Strong Seasonality Likely Pulled Forward, The Point of Maximum Optimism III
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There was nothing much doing in the stock market yesterday (Wednesday). Price didn’t move much and volume was notably light. Here were the performances for the major indexes: S&P +0.18% NASDAQ -0.05% Russell +0.11%. Volume on the SPY, QQQ and IWM were 58%, 50% and 77% their 3-month averages.
The only action I found systemically important was in Saleforce (CRM), which reported earnings Tuesday afternoon, which was -8.52% on 7x average volume. Its 200 DMA now appears to be in play for the first time since early May.
The Futures suggest today is shaping up to be more of the same: S&P Futures -0.17% NASDAQ Futures +0.12% Russell Futures -0.24% (as of 1:33am PST).
The country’s largest grocer, Kroger (KR), reports earnings later this morning and Ulta Beauty (ULTA) reports this afternoon.
After the historic move in November we wouldn’t be surprised to see below average returns in December – LPL, “Big Gains In November Steal From Santa”, 12/2
As I wrote Sunday morning, December has been the the 2nd best month historically since 1964 (“Strong Seasonality / Earnings Week of 11/30, Analyzing November”, 11/29). However, LPL Financial had a great chart in yesterday’s blog showing that when November > 10%, the S&P’s average return in December is actually -1% since 1950. As I wrote Sunday, it’s very likely that December’s strong seasonality was pulled forward by a historic November.
Sentiment continues to run extremely bullish. Call buying is exploding with an average of more than 20 million contracts traded over the last 20 days. 35 million contracts were traded on the day before Thanksgiving (Chart Source: Liz Ann Sonders Tweet, 12/2, 4:17am PST).
The other side of the coin is that put prices are collapsing, as shown by the VIX, as investors no longer feel the need for downside protection (Source: Tarek I. Saab Tweet, 12/2, 12:10am PST)
Another tell of extreme bullishness was Goldman’s upgrade of Tesla (TSLA) yesterday afternoon to Buy with a $780 Price Target. According to CNBC, Goldman said that TSLA can sell 15 million cars by 2040 – they sold 431,000 the last 12 months. At $780, TSLA would be worth more than $850 billion while its Non-GAAP EPS Excluding Sales of Regulatory Credits is 90 cents over the last 12 months.
S&P Resolves “Dueling Tails” To The Upside, The Point of Maximum Optimism II, The Economics of the $ Breakdown, CRM Earnings
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Yesterday, the S&P (3,662) and NASDAQ closed at all-time highs. Significantly, the S&P broke out to the upside of the range (3,646) established by the “Dueling Tails”, so beautifully charted by David Zarling, on Monday November 9 and Tuesday November 10 in the wake of the Pfizer COVID vaccine announcement. Technically, this resolution to the upside suggests even more upside ahead – if it holds.
Investing involves not just predicting the future but comparing it to what is already priced in. If everyone already expects everything to be great, and it turns out that way, there is no particular reason for asset prices to change.
And at the moment, it seems that everyone expects everything to be really fantastic – James Mackintosh, “Market Expects Everything Will Be Awesome”, WSJ, Tuesday 12/1
The two best things I read yesterday were James Mackintosh’s piece in the WSJ in the morning and Greg Rieben’s blog post (“Investors Are Becoming Fearless”, 12/1) on sentiment (via The Chart Report) in the afternoon. In his blog post, Rieben posts two important charts showing how frothy sentiment has become.
The first chart shows $71 billion of flows into global equity funds in the previous two weeks – the highest since at least 2008. Interpretation: Investors are piling into the market. The second shows the 10 Day Put/Call Ratio reaching 0.413. The last two times it went below 0.5 – early June and late August – were followed by sharp corrections This shows investors scrambling to gain leverage in the market via calls and ignoring downside protection via puts (see Rieben’s blog post for the charts as I was unable to copy them here).
Next, I want to talk about the economics of the dollar breakdown. The dollar index has broken down below support at 92, paving the way for a trip to the 2018 lows at 88.
The most important consequence of the dollar breakdown is its effect on holders of $ denominated assets, especially treasuries. Foreigners held $7 trillion in treasuries at the end of the 2Q20. If the decline in the $ versus their home currencies begins to overwhelm the return they are getting from their investment, they may very well start selling. Treasury selling means lower prices which means higher interest rates. And higher interest rates are one thing our debt laden economy cannot handle.
A second negative consequence of the dollar breakdown is an increase in import prices. Given how much of our production we have outsourced, this increase in import prices is inflationary for the real economy as consumers and businesses are required to spend more dollars on the things they import.
The one benefit of a weak dollar is that helps companies based here that export most of their production because it makes their goods cheaper for foreign investors. On balance, however, the dollar breakdown is very negative economically and for the stock market.
Lastly, I want to mention Salesforce (CRM) earnings from yesterday afternoon. Revenue growth decelerated to 20% in the quarter ended October 31, 2020 and they guided their fiscal year 4th quarter revenue to +17% – more deceleration. I believe this is why shares are down ~4% early in the premarket.
Market Commentary, Pricing In Normalization in 2021, The Point of Maximum Optimism, ZM Earnings
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Yesterday’s correction was a normal consolidation within an uptrend that did no technical damage (S&P > 3600, NASDAQ > 12000, Russell > 1800). Here were the returns for the major indexes:
S&P -0.46% NASDAQ -0.06% Russell -1.91%
In fact, the Futures currently suggest the S&P and NASDAQ will more than recoup yesterday’s losses today while the Russell will recoup most of them.
BeSpoke had an excellent chart breaking down yesterday’s returns for the Russell 3000, which includes the Russell 1000 of large cap stocks plus the Russell 2000 of small cap stocks, by performance decile in November through Friday November 27. The better a stock had performed through Friday, the worse it did on Monday with the two best performing decilies each off about 1.9%. This is normal profit taking and should be of no concern to bulls.
The prospect of vaccines returning life to normal injected wild hope into many of the least popular assets. Exxon Mobil is up 23% so far in November, putting it on track for its best month since at least 1972. The Russell 2000 index of small stocks, up 21%, is heading for its best month since at least 1988.
The lockdown losers hit the worst this year are doing incredibly well this month, with 9 S&P stocks up more than 50%. Boeing, cruise lines Carnival and Royal Carribean, several airlines, mall owners, hotels and entertainment stocks, and Citigroup are up more than a third. The VIX gauge of implied volatility has plunged from a pre-election high of 41 to flirt with the summer lows just above 20.
Junk bonds, rated as close to default, or triple-C, have returned 7.3% so far in November, on track for their best month since the panic about shale oil in 2016.
Cyclical stocks sensitive to the economy have done very well, while defensive stocks able to ride out recessions are in less demand. In particular, some of the stocks that won as we stockpiled groceries and worked from home have lagged behind badly this month: disinfectant company Clorox, Newmont and Spam maker Hormel Foods are all down, even as the market is up. The haven of gold has fallen, too.
The message is clear: things are looking better.
– James Mackintosh, “Recovery Hopes Fail to Rally Bonds”, Monday, November 30, WSJ B1
James Mackintosh did such a good job summarizing November’s action that I decided to quote from his column in yesterday’s WSJ at length. My concern is that November’s action appears to me to have already #PricedIn a return to normal in 2021. Therefore, even if that optimistic scenario comes to bear, stocks may not go higher given the moves we saw in November.
The best example of the extremity of the action in November is the Russell 2000 index of small caps. It had its best month on record while breaking through the previous all-time high of 1740 from 2018 on its way through 1800.
Also reflecting the widespread belief in a 2021 normalization is copper, the metal with a Phd in Economics due to its correlation with economic activity, which broke out of a multi year range.
As I wrote on Sunday morning, the market can actually top when things look the best as all of the good news is priced in. We may be at one of those moments right now.
Investors are almost universally bullish. It’s very hard to find a bear on 2021 – Mike Wilson, Chief US Equity Strategist, Morgan Stanley (Source: CNBC.com, Monday November 23)
Stock prices have reached what looks like a permanently high plateau – Economist Irving Fisher, October 1929
Invest at the point of maximum pessimism and sell at the point of maximum optimism – John Templeton
Be fearful when others are greedy and greedy when others are fearful – Warren Buffett
This feels to me like the point of maximum optimism or Euphoria phase of The Cycle of Market Emotions. While everybody is scrambling to get long for the 2021 reopen and the anticipated next leg up in a new bull market, I’ll take the other side. I think this is a time for extreme caution and taking chips off the table as such a scenario now appears to me to be #PricedIn It’s very hard for me to see a scenario in 2021 that justifies higher stock prices.
Lastly, a word about Zoom (ZM) earnings from yesterday afternoon.
While the numbers looked good with Revenue +367% from a year ago and 99 cents Non-GAAP EPS, the stock finished the after hours -5.04% and is currently down more than 7% in the premarket.
I believe this is a function of extreme valuation (167x current year guidance based on Monday’s closing price) and concern about the implications of reopening for its business. ZM is the purest #Lockdown #PandemicBenificiary stock and so with the vaccines and a 2021 reopen, it is probably not the right place to be right now.
Strong Seasonality / Earnings Week of 11/30, Analyzing November
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The first thing to know is that December, which begins on Tuesday, has been the second best month for the S&P since 1964. It has been positive 71% of the time since 1964 with an average gain of 1.3%.
Investors have become uninterested in worrying about downside risks – Tobias Levkovich, Chief US Equity Strategist, Citigroup, quoted in Ben Levisohn, The Trader Column, Barron’s, November 27
However, I am not sure it will be a great month this year because of how strong November has been. According to Ben Levishohn in yesterday’s The Trader Column in Barron’s, the S&P was +11%, the NASDAQ +12% and the Russell +20% in November. Stocks don’t go straight up. My feeling is that December’s strong seasonality has been pulled forward by the huge moves we saw in November.
There are actually a number of significant earnings reports next week. Zoom (ZM) reports on Monday afternoon, Salesforce (CRM) Tuesday afternoon, Kroger (KR) Thursday morning and Ulta Beauty (ULTA) Thursday afternoon.
Now that we’ve set the stage for next week and December, let’s review what happened in the historic month of November 2020.
The key events of November were the announcement of the effectiveness of COVID vaccines from Pfizer (Monday, November 9) and Moderna (Monday, November 16). These announcements catalyzed a radical rotation in the market out of the stay at home, pandemic beneficiary stocks, many of them tech stocks well represented by the QQQ (NASDAQ-100 ETF), into reopen, real economy stocks that skew value and are well represented by the IWM (Russell 2000 ETF). According to Ryan Detrick of LPL Financial, the Russell 2000 was +20.5% through Tuesday, November 24th, and is on pace for its best month ever.
The great technician Carter Worth put up a chart on Twitter on Wednesday, November 25 showing the relative performance of the S&P Financial, Industrial, Material and Energy sectors, also a good proxy for reopen stocks, to the the S&P 500. If you look at the bottom chart, you can see that this basket of equal weighted stocks hit a downtrend line versus the S&P from late 2016 at which it failed. Worth’s conclusion is that the rotation trade is now to be faded: “Conclusion: Fade the collective move in Financials, Industrials, Materials and Energy” (https://twitter.com/CarterBWorth/status/1331635784949133315?s=20).
The best chart I saw last week was from @SoccerMomTrades which showed the Russell 2000 making a 3 standard deviation move in November. That has only happened 3 other times since 1994 – Sep97, Feb00 and Apr09 – the latter two of which were the top of the Dot Com Bubble and the bottom of the Great Recession. This suggests to me that November’s move in the Russell may have been a blow off top marking the end of this bull market. This is in line with Carter Worth’s analysis as well.
Along with a potential blow off top type of move in reopen, real economy, value stocks, Big Tech is consolidating, mostly well below their 52 week highs from September 2. The chart’s author, Gregory Krupinski, commented: “All consolidating within uptrends. Obviously, the way these break will have big impacts” ((Gregory Krupinski, Twitter, November 25, 1:45pm PST: (https://twitter.com/G_krupins/status/1331715584946548740?s=20)).
A blow off top type of move in value combined with a breakdown in the four biggest stocks in the world would inevitably mean the end of the bull market.
And it’s not just the price action that has gotten extreme in November. Sentiment has become historically bullish. The Put to Call ratio on S&P stocks has dropped to historic lows as investors shun insurance (puts) in favor of leveraged long bets (calls). Arun Chopra has a beautiful chart illustrating the shift from extreme fear in March to extreme greed in November.
I’ve already discussed extreme breadth and extreme overvaluation in recent morning emails so I’m not going to discuss them here but they are part of the overall mosaic as well.
In conclusion, while the crowd is becoming mega bullish ahead of the COVID vaccines and a 2021 reopen, measures of price action, sentiment, breadth and valuation are at historic extremes, the type of extremes you see at major market inflection points. Paradoxically, the market can top when things look best as all of the good news is priced in. I think this is a time to be very cautious, not put on additional risk like the crowd.
Market Commentary, Extreme Sentiment & Breadth, Bitcoin $19k & a Shoutout to The Chart Report
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The market has caught fire this week. After a solid Monday (only the Russell 2000 was very strong at +1.85%), everything was up yesterday:
S&P +1.62% NASDAQ +1.31% Russell +1.94%
We now sit right on the verge of a breakout to new ATHs for the S&P and NASDAQ while the Russell is making new ATHs almost everyday. In fact, the Russell is +20.5% through Tuesday (11/24), its best month ever according to Ryan Detrick (Chart Source: Twitter: @RyanDetrick). More than 80% of its components are above their 200 DMAs, the most since at least 2014 (Chart Source: Twitter: @PrattyCharts). And while the S&P and NASDAQ had excellent days yesterday, the #Rotation trade is still on in full force as investors continue to rotate from #StayAtHome #PandemicBenificiary stocks into #ReOpen names (Chart Source: Twitter: @murphycharts).
That’s what’s happening in terms of price. Now I want to discuss an excellent blog post from Sentiment Trader’s Troy Bombardia on extreme sentiment and breadth, known in technical analysis as internals (“Once in a Blue Moon Sentiment and Breadth, Bombardia, 11/24: https://sentimentrader.com/blog/once-in-a-blue-moon-sentiment-and-breadth–24-11-2020/). 59% of Sentiment Trader’s sentiment indicators are showing excess optimism right now, a 15 year high. As I wrote yesterday mornings, the vaccines news and the breakout in the Russell 2000 has gotten everyone all bulled up. Since 1998, this kind of extreme sentiment has always led to months of chop, pullback or even crashes.
Although we have been covering this quite a bit in the morning email, Bombardia also points out that breadth is also extreme. For example, 90% of S&P components are above their 200 DMAs. While the sentiment readings are short to medium term bearish according to Bombardia, the breadth readings have been unambiguously bullish since 1998 with the S&P being up 99% of the time 1 year later. Bombardia concludes:
The two narratives can coexist if we consider two different time frames. While unimaginably high sentiment can and usually does lead to short term losses and volatility, incredibly strong breadth is more of a long term bullish sign for stocks.
It’s hard to argue with 99% but I’m going to. While Bombardia’s data shows the incredibly strong breadth to be bullish one year out since 1998, I think it’s one more sign of a blow off top this time around, in conjunction with sentiment, valuation and macro considerations. To be blunt: There is a bubble and it’s close to popping.
Lastly, a few loose ends. Bitcoin has surpassed $19k and clearly has a date with its December 2017 ATHs just below 20k (Chart Source: Twitter: @AndrewThrasher).
Finally, I simply must give a shoutout to Patrick Dunuwila, the creator of The Chart Report. All six charts in this email are from Tuesday’s The Chart Report and I found Bombardia’s blog post from it as well. I have three essential sources in my daily market analysis routine: corporate earnings reports (Fundamental Analysis), The Wall Street Journal (News and Fundamental Analysis) and The Chart Report (Technical Analysis). You know you’re in good company when a fundamentally oriented trader like me puts you on a par with the hard fundamental data of corporate earnings reports and what I believe to be the greatest newspaper in history. You’re killing it Patrick! Add The Chart Report to your daily market routine folks. It’s that good.
Small Cap Mania, Extreme Bullishness, The $ At Support
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Yesterday’s action, especially in the small cap Russell 2000, seems to have lit a fire under financial markets. Here are yesterday’s returns for the major indexes:
S&P: +0.56%
NASDAQ: +0.22%
Russell: +1.85%
The Russell 2000 is now having its best month ever, up ~18.4% through yesterday (Chart via Ryan Detrick).
In its wake, Japan’s NIKKEI was +2.50% overnight (Tuesday in Japan) and we are ripping again today: S&P +1.45%, NASDAQ +1.05% and Russell +1.75% as of 8:40am PST.
The imminent correction I called for, based on Andrew Thrasher’s argument, data and chart in “Can you have too much of a good thing?” (November 17: https://www.athrasher.com/can-you-have-too-much-of-a-good-thing/), prior to a nice year end rally, does not seem to be materializing. Instead, we are just continuing to rally without letup.
Investors are almost universally bullish. It’s very hard to find a bear on 2021 – Mike Wilson, Chief US Equity Strategist, Morgan Stanley (Source: CNBC.com)
The breakout in the small caps above their 2018 highs around 1740 and now their follow through through 1800 yesterday has ignited a bullish mania, especially among technicians.
Yesterday’s The Chart Report’s Chart of the Day (https://www.thechartreport.com/11-23-20/) was a beautiful monthly 5 year chart of the Russell 2000 by Jason Leavitt clearly showing its breakout to new all time highs. Also interesting was his commentary: “If you’re looking for a top, STOP. We’re closer to the beginning of the move not the end” (Jason Leavitt, Twitter, Monday November 23, 11:34am PST: https://twitter.com/JasonLeavitt/status/1330957936231915523?s=20).
Another technician who shares the view that this is the just the beginning of a new bull market is Dan Russo (“What if this is the start of the bull market?”, November 16: https://mareamarketmusings.substack.com/p/what-if-this-is-the-start-of-the?utm_campaign=post&utm_medium=web&utm_source=twitter). Russo’s post contains some recent market history but his argument boils down to the strength (at the time) and now breakout in the Russell 2000 which he believes, correctly IMO, closely reflects the real economy.
I tweeted Russo’s blog post with the the commentary “Another technician who thinks this is just the start of a new bull market” (Top Gun Financial, Twitter, Monday November 23, 2:59pm PST: https://twitter.com/TopGunFP/status/1331009558580318209?s=20). Happily, Russo is not one of those rigid dogmatists unwilling to engage with those with differing points of view. He replied that he was willing to entertain bearish views and we had a nice 20-30 minute exchange on Twitter.
Dan demonstrated his extensive knowledge of pricing across a broad array of markets as well as intermarket relationships, the ability to interpret the meaning of the ratios between the prices of various assets. For example, Dan pointed out how investors were moving out on the risk curve in fixed income, how copper was outperforming gold as well as the significantly broadening breadth of the rally (catalyzed by Pfizer’s COVID vaccine study results announcement on Monday November 9).
I quickly discovered that I was engaged with a worthy opponent. What was ultimately revealing for me was that Dan and I kept bumping up against the same issue: all his arguments were price i.e. technical ones while price only reflects investor perception not economic reality. (Like most technicians, Dan has a different take on the meaning of price). When I pressed him on this, he finally cited some fundamental reasons to be bullish but it was half hearted. I’m sure that even he will admit that he’s bullish because of the price action i.e. technicals.
For me, technicals are never a reason to have a long term view. Technicals tell you what’s happening right now and how investors are positioning themselves going forward. It is a pure reflection of investor psychology as distinct from economic reality which can only be gleaned by doing fundamental analysis on corporate earnings reports as well as Macroeconomics (which, admittedly, is less precise and more of an art).
I ultimately suggested that Dan and I were unlikely to persuade one another because our investment philosophies were “incommensurable”, but the exchange appears to have been profitable for both of us as we followed each other on Twitter. The best way to develop and improve one’s views IMO is to engage with the best that can be said from the opposing point of view. While this is emotionally difficult to do, and therefore few are willing to do it, I personally seek it out and was fortunate to find someone who does as well. Thank you Dan!
Before wrapping up, I want to point out that the dollar index is close to breaking down below previous support at 92 (Chart via Carter Braxton Worth).
What’s interesting is that there is a debate about whether this is bullish or bearish for risk assets. As some of you know from previous writing, I think it’s bearish as a declining dollar means higher import prices for our import reliant economy which means inflation. In addition, a declining dollar could cause foreign investors to sell dollar denominated assets, especially treasuries, as the decline in the dollar versus their home currency overwhelms any return they are getting, resulting in higher interest rates.
Some technicians (Russo and Gary Savage, for example), however, believe dollar weakness is bullish. A weakening dollar does seem to light a fire under risk assets and this is more than mere correlation. Anything priced in dollars goes up as the dollar declines in value generally, but, for some reason, especially risk assets. There is an argument as to why but I can’t for the life of me articulate it at the moment.
At any rate, this should be on your radar. We’ll see what the implications are for the economy and risk asset prices should the dollar index break down below 92.
The Likely Narrative Through Year End, The Bear Market Rally of 1929-30, Historic Overvaluation
The vaccine announcement has given bullish investors a put option – Jim Paulsen, CIO, The Leuthold Group on “The Vaccine Put”, quoted in Ben Levishon, Barron’s, The Trader Column, November 21, 2020
For the last 6 weeks of 2020, I expect markets to trade on on the premise that a vaccine means a reopening and the beginning of a return to normal in 2021. I am calling this “The Vaccine Put”. (For years investors have referred to “The Fed Put” as protecting them from downside as the Fed continually steps in to prop up the market when trouble arises).
In addition to the bullish narrative, we are in the most seasonably bullish period of the year, a data light stretch in which the bullish narrative is likely to cause stocks to drift higher into year end (after a small correction that I’ve been writing about based on Andrew Thrasher’s argument that the market is currently too strong).
I have already discussed how I intend to trade this in recent morning emails.
History doesn’t repeat itself but it often rhymes – Mark Twain
I started studying the parallels between the current market rally and the bear market rally of 1929-1930 early on. After peaking at 381.17 on 9/3/29, the Dow Jones Industrial Average started to slide and then crash, bottoming on 11/13/29 at 198.69, a 48% decline in a little over two months. The current market peaked on 2/19/20 at 3386.15 and then crashed for a month (“The COVID Crash”) bottoming at 2237.40 on 3/23/20, a 34% decline.
This time around, the crash was shallower as the Fed’s policy response was swift and strong, unlike in 1929. That also accounts for the increased magnitude of the current rally in my opinion. From 11/13/29, the market rallied for 5+ months reaching 294.07 on 4/17/20, a 48% increase. The meat of the current rally also lasted a little more than 5 months, reaching 3580.84 on 9/2/20, a 60% increase to new highs. Because of the Fed’s swift and strong policy response this time around, it was able to arrest the decline and reignite the bull market to new highs. If history is any guide however, and the chart suggests we are topping out, I expect the bear market to begin in early 2021.
In this weekend’s WSJ, in his Intelligent Investor column, Jason Zweig denied that the stock market was in a bubble citing a 21x forward P/E ratio. Unfortunately, that is the wrong metric to use as it is based on overly optimistic analyst assumptions. Both Jim Stack’s Investech Newsletters, which cites the market’s trailing 12 month P/E ratio, based on earnings that have already occurred, at 36.17, along with a number of other metrics including the Price / Sales ratio and the Buffett Indicator and Crescat Capital’s Valuation Model suggest this is in fact the most expensive market in history i.e. a bubble.
Those of you who follow me on Stocktwits and/or Twitter know that I have been going through stocks meticulously during 3Q Earnings Season, pointing out their overvaluation one by one. Last week, I showed this with regard to WMT, HD, NVDA & WDAY, none of which could get any traction off of good to great quarters.
May you live in interesting times – a Chinese Curse
Minervini on Tops and Selling, The Indexes Are Topping, Adding SPG & XOP to the Year End Trade
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I normally don’t write morning emails over the weekend but I have enough to say this morning that it makes sense.
The last section of yesterday’s Day 3 of Mark Minervini’s Master Trader Program was on tops and selling. According to Minervini, while buying is somewhat mechanical, selling is more of an art. You look for a number of things in the price action such as climactic buying which signals exhaustion rather than breakout at the end of a move. He ran us through a number of charts of climactic buying and tops followed by Stage 3 topping processes and then Stage 4 sell offs and it reminded me of the current action in the major indexes (see Mark Minervini, Trade Like A Stock Market Wizard (2013), Chapter 5 “Trading With The Trend” for the 4 technical/price stages a stock goes through).
Starting with the NASDAQ, it seems pretty clear that 12,000 is at least very strong resistance. We first pierced it on September 2 and, while bumping up against it since then, have not been able to convincingly break through it in the 2 1/2 months since. With the rotation trade out of tech into value ahead of an expected 2021 reopening based on the COVID vaccines, I don’t see how the NASDAQ pushes through 12,000.
The S&P is less tech heavy, more balanced, than the NASDAQ and so it’s topping process looks a little different. The September 2 high was marginally breached on November 9 on the Pfizer COVID vaccine news but 3,600 still looks like very stiff resistance. Again, we’ve mostly gone sideways since September 2.
The Russell is trickier. We broke out to news highs on the Moderna COVID vaccine news last Monday (November 16) with a little follow through on Tuesday November 17 and while making the case for a top here is tougher technically, based on the other indexes, the age of this bull market, valuation and other considerations, I believe 1,800 will be a tough level to sustainably crack, though a marginal new high above it before year end wouldn’t surprise me.
This has two implications for me. First, it means that I’m going to need at least a 3% correction in the Russell to put on my year end trade as I believe 1,800 is stiff resistance and only a marginal new high is possible. A retest of the breakout from the 2018 highs at 1740 would provide sufficient room for a nice 3-4% year end bounce to finish around 1800.
Second, it means that I don’t want to hold this trade past the first trading day of January 2021, as I believe 2021 will mark the onset of a very nasty bear market. More on this another time or you can peruse my website in which I cover my reasons for why this bull market is on its last legs in many previous Client Notes.
I read a terrific article by Liz Moyer in Barron’s yesterday on Simon Property Group (SPG) as a great way to play the reopen trade (SUBSCRIPTION REQUIRED:https://www.barrons.com/articles/the-mall-isnt-dead-why-its-time-to-go-shopping-for-simon-property-stock-51605887581?mod=past_editions). As investors anticipate a 2021 reopening, they should rotate out of online commerce stocks like Shopify and Amazon, which have had enormous run ups, into brick and mortar retailers. As the owner of 16 of the top 30 malls in the US, SPG is a perfect vehicle for playing the rotation trade.
I also think playing it via the SPDR Oil Producers and Exploration ETF (XOP), which I just traded for a 35% gain in 2 1/2 weeks (https://stocktwits.com/TopGunFP/message/257587327), makes a lot of sense.
Lastly, I will put on smaller positions in the Russell 2000 via IWM and Japan via EWJ.
But I need that ~3% correction, as previously discussed, to make this trade make sense to me.
It’s not about being an optimist or a pessimist but a realist. What that means in financial markets is understanding the distinction between price (perception) and fundamentals (reality) and the catalysts that may cause the two to converge #Variant Perception #Price vs #Value – TopGunFP, Twitter, Friday November 20, 4:12pm (https://twitter.com/TopGunFP/status/1329940600284536833?s=20)
To sum up, there are a lot of moving pieces but let’s focus first on what’s in front of us: the last 6 weeks of the year. We’re looking for a correction to put on the year end trade for a nice cap off to 2020. However, we will not overstay our welcome as the market is topping and I expect 2021 to be the start of a nasty bear market. Therefore, we will close out this trade on the first trading day of 2021.
We’re essentially trading perception embodied in price rather than reality embodied in the fundamentals in making this year end trade. We’re betting that the crowd doesn’t wake up to the reality of the popping stock market bubble and ensuing bear market until next year.
WDAY Earnings, Extremely Bullish Seasonality Through Year End, To Short Or Not To Short
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Yesterday afternoon, Workday (WDAY) reported a solid quarter (Revenue +18%, EPS +62% to 86 cents) but saw its shares sell off in the after hours. We’ll see how it does in today’s trading session but this is the fourth time we’ve seen this kind of action in a stock this week (WMT, HD & NVDA): A good or even great quarter that can’t move the stock higher or the stock even sells off on because it’s technically extended and overvalued and so the numbers are already #PricedIn
And these aren’t the only four stocks, as I’ve been documenting this phenomena throughout earnings season. The market is overbought and overvalued and is having a hard time moving higher from here as a result. For your reference, here are the valuations for WMT, HD, NVDA and WDAY (I use Price / Trailing Twelve Month (TTM) EPS or EV / TTM if the company has net cash to give it credit for that). Trailing P/Es:
WMT 28x
HD 23x
NVDA 61x
WDAY 86x
In general, you don’t make money long term buying stocks at these various stages in their growth cycles at these valuations. It doesn’t mean that you won’t this time, but the probabilities are against it.
A secondary reason for wanting to make the IWM & EWJ trade, after a correction, is extremely bullish seasonality from now until year end. After today, we have 6 data light weeks, two holiday shortened. With investors so bullish and the #COVIDVaccine causing the rotation into #Value from #Growth as investors anticipate a #2021 #ReOpen, I expect that narrative to control the action as stocks drift higher into year end with seasonality acting as a tailwind.
The best reason for staying away from shorting stocks is the overriding 10% annual return for the past 200 years. One way of seeing this is to dig up a long term chart of the stock market averages…. The overall impression is a continuous rise of some 100-fold over the past 100 years, with pauses in the 1930s and 1970s, and small downward blips in 1907, 1929, and 1987 – Niederhoffer, The Education of a Speculator (1997), pg. 268
Soros once told me that he lost more money selling short than any other speculative activity. My experience is similar. The advice that comes down the pike from authors of stock market doom books – that individual investors should sell short – is a ticket to the poorhouse – Niederhoffer, pg. 46
Now, I’m going to step back and look at the broader issue of shorting stocks and how it applies to my trading.
I made my first trade in February 2000 after I read an article by the Austrian/Objectivist economist George Reisman that we were in a stock market bubble. My parents had given me $1500 in EMC stock as a high school graduation present in June 1995 and that had appreciated to ~$20,000. I decided to sell and put it in the Vanguard Wilshire 5000 Index Fund as the investments course I had taken in the fall of my final year at UC – San Diego recommended. Sure enough, Reisman was right, the Dot Com Bubble peaked in March, and EMC stock dropped 90% in the ensuing years (unfortunately the Vanguard Wilshire 5000 Index Fund dropped 50%).
In 2005, I was a Philosophy Phd student at UC – Davis when the housing bubble came on my radar. Having been exposed to the ideas of Ludwig von Mises and the Austrian School of Economics and their theory of the business cycle in college, I understood exactly what was going on: overly low rates from the Fed had stimulated a national housing frenzy which was going to pop. I decided to wrap up my MA and started Top Gun in 2006 to profit from the implosion of the housing market and its ripple effects into the rest of the economy. I went live on January 1, 2007, shorted housing stocks and the investment banks holding mortgage backed securities on their books, the market peaked in October, I returned 15% in 2018 compared to -38% for the S&P, and I was managing $4 million by early 2009. I thought I was on my way.
Unfortunately, I thought that March 2009 was simply a countertrend rally in an ongoing bear market, not the bottom of The Great Recession and I remained bearish and short after trading the oversold bounce. After being right to bet against the market in 2000 and 2007, this was the beginning of a long period of being wrong. My performance deteriorated and my AUM shrunk to its current $2 million.
I thought COVID marked the end of the 2009-2020 cyclical bull market and became bearish and started shorting the stock market in May, not throwing in the towel until October (5 months). I was caught off guard by the massive and overdone rally we’ve seen since March 23 and my short campaign cost me and my clients a significant amount of money.
I’m in a very self reflective period right now, as those of you who read Monday’s morning email know (“The Return of Value?, Breaking My Value Trap Habit / Mark Minervini on Leaders Vs Laggards, Integrating Not Imitating Minervini”, Monday November 16, 2020: https://www.topgunfp.com/the-return-of-value-breaking-my-value-trap-habit-mark-minervini-on-leaders-vs-laggards-integrating-not-imitating-minervini/), and I had an epiphany yesterday afternoon about my shorting. I realized that I was placing being right above making money. It was about being right when everyone else was wrong. I was trying to be a hero and that is not the right way to invest.
I picked Victor Niederhoffer’s magnificent The Education of a Speculator (1997) off my shelf because it had a couple great passages on shorting that I had written about in a Client Note from 2012 entitled “The Loser’s Strategy”, which has unfortunately been lost from my website, and which I quoted from above. I think I’m done shorting. I’d rather profit more safely from the popping of the current bubble by being long gold which will benefit when the Fed steps in to prop up a collapsing securities market than being short in a situation in which the institution that controls the money supply is pumping tens of billions monthly (trillions total) into financial markets. I got burned May through September, have watched as one of my investing heroes, David Einhorn, has continued to lose money on his “Bubble Basket” of shorts for years now, and have concluded that I am done shorting. In conjunction with the self analysis on my penchant for Value Traps and lack of Risk Management in Monday’s morning email, it has been an incredible week of self analysis and self development as an investor. I’ve never felt even close to as good about my stock game as I do now, having patched up three major leaks, going forward. The best is yet to come.
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