Financial Advisors

Code Orange for the Forever Market?

Simply put, nothing lasts forever, including this impressive bull market. Of course, everyone wants to know how much longer can it last? No one really knows. Are there reasons to think it's sooner rather than later? Sure, but how many tops have been called the last few years?

In 2000 valuations and relative performance in the tech space were even crazier than we're seeing now. It was all tech all the time, and nothing else, as you can see in the table below from Jonathan Krinsky, CMT. What caused the top then? Well, my personal opinion is that too many stock unlocks from recent IPOs hit the market at the same time around March 2000, causing overwhelming supply, but I’ve never seen a widely cited reason for the tech bubble bursting. It just happened eventually. Sic transit gloria mundi (thus passes worldly glory).

Table

Similarly, there were lots of warning signs of trouble in 2008, but what really caused that crash? There were warning signs in credit way back in 2006. Did anything cause stocks to peak in early October 2008? Not really. Sure, there were troubles, but that had been going on literally for years. The problems were obvious then, but today it again seems pretty common for the stock market to only slowly and reluctantly price in problems. They don't ring a bell at the top of a market to warn investors.

That leads us to now. I think the current problems have been obvious for quite a while. Eventually there's going to be trouble, but at what point do the warning klaxons get loud enough for the market to care? That seems impossible to know. What are the basic warning signs? I think you can look at two basic problems, Fed and Congressional stimulus, and macro-economic data.

For quite a while, many have claimed that you can't worry about the market until the Fed stops flooding the market with money. To their credit, they have been right, but the taper of the Fed’s Treasury bond and Mortgage-Backed Securities purchases started this month. When does that have an effect?

To some extent, you could claim it already may have had an effect. I think that's clearest in the tech space. Sure, some large tech companies are playing a significant part in keeping the market going, but plenty of high growth tech stocks have been struggling of late. As Helen Meisler says in her article, This Market Needs a Doctor, the number of stocks making new lows on the Nasdaq is now a bit over 400, the highest reading since the dark days of Covid in March 2020. Take a look at the list of popular names below, as of November 22, 2021.

Table

Sticking with the stimulus theme, it's also worth noting at least in passing that even the most optimistic estimate of fiscal spending is going to represent a slowdown from what we had. The idea has been that we would have a graceful handoff from Covid stimulus spending to a recovering real economy. We'll see.

That leads us to macro-economic concerns. We had a bit of a bobble in the third quarter, with a 2% GDP print, but optimism is high that GDP will bounce back strongly in Q4. We'll see. In the early going, we've seen a bit of a mix, but I think it's fair to say there's been a bit more good than bad in recent economic data.

There are definitely points for concern. Inflation has remained elevated, though the recent smackdown in oil prices may help. Is inflation at least part of why consumer confidence recently hit 11-year lows? Considering how important the consumer is to our economy, that seems pretty troubling. Buying conditions for large items like cars and houses look particularly brutal.

Chart

Counterposing that is that we are around a time of year that has strong, positive seasonality, market inflows have been record breaking all year, and investor sentiment has been very strong. Can that take us through to the end of the year? It certainly has before, and a lot of people seem to be leaning that way.

And maybe they're right. At some point in the next several months, we can say stimulus is not going to be our friend any longer. At some point in the next several months, year-over-year base effects from Covid stimulus seem likely to make the economy look worse. When does it hit the market? Trying to pace through all that, I would think we have to see a negative effect within the next six months. Can we get through all of 2022 without anything breaking?

The basic question is always how you invest given the evolving macro-economic environment. To me, the primary recent change in the market is liquidity getting incrementally worse. You can say it doesn't matter, but I wonder if that's the cause of the breadth problems in the high growth stocks. Sure, there are some winners, but there have also been some big losers. Investing in high growth companies seems to have become riskier. Can that reverse? Of course, but for now aggressively buying high growth is starting to look more dangerous.

In general, if you're going to stray from the index, I would favor cheap, defensive stocks. Sure, you're not going to be involved in the game of hoping your stock gets gamma-squeezed up 50% by the end of the year, but you're also not going to risk hitting the reverse slope of what happens afterwards. Recall the Softbank gamma squeeze around August 2020. There were great gains in August, but September saw them all disappear. We've seen a lot of aggressive options activity lately. Will that run out of steam like we saw last year?

I continue to think there are good and reasonable places to invest in the market right now, but right now I also think it's fair to say there's been a large amount of very speculative activity based on factors other than earnings and valuations. For instance, short-dated options activity is through the roof. That's fine as long as it keeps coming, but once we see even a slowdown, things may get difficult for the underlying stocks and indexes, as we've seen with tech breadth.

That's also my fundamental problem with some of this speculation. My personal opinion is that speculation was even worse in 2000, and the aftermath of the bust was incredibly painful for some people. The gap between speculators and fundamental buyers was then, and is now, huge. That's why some of the stocks noted above are dropping 70% or more, and may not be done. I'm just not that interested in trying to wring all the juice out of these popular stocks. Trouble is clearly going to come. I can't say it's coming right now, for sure, but I'm comfortable declaring a Code Orange caution for this market. There are some grim looking storm clouds out there for Fed and Congressional stimulus, and macro-economic data. It may take some time for them to hit, but I want to find a spot to hunker down.

BLOG DISCLOSURE / ACKNOWLEDGEMENT

This blog is provided for informational purposes only. The information on this blog is based on SCM’s personal opinion and experience and should not be considered professional financial investment advice. The information does not take into account your own personal circumstances or risk tolerance. Our ideas and comments should never be used without first assessing your own personal and financial situation and consulting a financial professional or attorney.

SCM’s thoughts and opinions on this blog are subject to change without notice and should not be taken as a recommendation to buy, hold or sell any security or investment strategy offered by SCM. Any reference to a stock’s past or potential performance is not a recommendation or guarantee of a particular outcome. Any securities identified and described do not represent all of the securities purchased, sold, or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable. Past performance is not indicative of future returns. SCM does not endorse and is not responsible or liable for any content, advertising, products, services, or information on or available from third-party websites or materials.

The views expressed herein represent the opinions of Symons Capital Management and are not intended to predict or depict performance of the market or any particular investments. Any index or individual security information cited in this commentary is intended to show the trends in certain markets or market conditions in the periods indicated. Although great care is taken to ensure the accuracy of all information posted, the author does not guarantee its accuracy or authenticity.

You are not permitted to reproduce, duplicate, copy, sell, resell or exploit for any purpose, any portion of this blog, or any data or image contained in this blog.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Other Topics

Stocks

Colin Symons CFA

Mr. Symons, who holds the Chartered Financial Analyst designation, is Chief Investment Officer and Portfolio Manager of the Symons Capital Management Value, Strategic Wealth and Small Cap Value strategies. In conjunction with his portfolio management responsibilities, he oversees and is principally responsible for the company's independent equity research. Mr. Symons joined Symons Capital Management in July 1997 after working as a software developer in Washington and New York, concentrating on financial services applications for entities such as Chase Manhattan Bank and the Internal Revenue Service. While he was a software developer, Mr. Symons earned the prestigious designation of Microsoft Certified Solution Developer. Mr. Symons earned his BA at Williams College in three years, at age 20.

Read Colin's Bio