Euphoric U.S. Stock Market and Pandemic Plagued Economy in Total Opposition


By the Curmudgeon




The disconnect between the euphoric U.S. stock market and struggling real economy has never been greater.  Despite a pandemic that has killed more than 300,000 people, put millions out of work and shuttered businesses around the country, the market is now somewhere between euphoria, nirvana, and utopia.


Institutional investors who have been bullish for much of 2020 are ignoring what’s happening in the real economy and continue buying stock because “the market is going up.”  They are comforted by the Fed’s continued zero interest rate policy (ZIRP) and monthly buying of about $80 billion worth of Treasury debt and $40 billion in mortgage-backed securities.  The Fed has indicated that program will remain intact for an indefinite time period.


Individual investors have piled into the market this year and are trading stocks at a pace not seen in twenty years. That’s driving a significant part of the market’s upward trajectory and is evident in recent frothy IPO prices, which we described in this article.  Brokerage houses say strong demand from individual investors drove the surge of trading in Airbnb and DoorDash – neither of which are profitable. Professional money managers largely stood aside, astonished and in awe at the prices smaller investors were willing to pay.


Let’s take a deeper look at what’s happening in the markets and real economy and offer our thoughts on same.  In a companion piece, Victor provides a Perspective on Monetarism, Valuations and Manias.


Examples of High Valuations and Speculative Excess:


·       The trailing 52 week price-to-earnings (P/E) ratio for S&P 500 index is 39.94 while last year it was 25.23 (source: Wall Street Journal).  The last time that market index was at or above that level was in 2000.

·       The current Shiller PE Ratio is 33.71, which is more than double the median of 15.1 and the mean of 16.3.  It’s based on average inflation-adjusted earnings from the previous 10 years and is also known as the Cyclically Adjusted PE Ratio (CAPE Ratio).

·       The Tobin Q ratio (the ratio of the market value of equities to the net worth of corporations at replacement cost) is at an all-time high in both adjusted and non-adjusted terms.  Both measures are above previous highs in 2000. Please see Tobin Q graph below.

·       Russell 2000 (small) companies should be hurt more than large caps by the COVID-19 lockdowns, business closures, restrictions, etc. Nonetheless, Russell 2000 stocks have rallied like a rocket ship! The small cap index has gained 102% off its March 18th low, only the second time it has doubled off its bottom in its entire history.  It was up over 18% in November – a new record.  All that came with no corrections or backing and filling, let alone a test of the March lows.  According to the Biryani Associates, the current FORWARD 12-month P/E for the Russell 2000 is 79.96.  The trailing P/E cannot be calculated since there was a cumulative loss (e.g., negative earnings).

·       Individual speculators have returned to the market in mass, for the first time since the dot com bubble. For many, trading stocks started as a way to indulge their speculative itch when other avenues, such as sports gambling, were shut down.  That has continued unabated as stocks continued their inexorable trend higher this year.

·       Small specs are throwing money at trendy, tech-focused companies, which are relatively new and unproven. Their favorites include cloud computing software maker Snowflake, the online surveillance company Palantir and the energy storage company QuantumScape, which is up 144% in December alone. They also like Etsy, the online marketplace, which is up 330% this year. Just over a week ago, 908 Devices — a maker of hand-held analytic devices — rose about 150% in its trading debut.

·       For IPOs in December, shares on the first day of trading skyrocketed 87%, on average, as of the week that ended Dec. 18. That’s the highest since early 2000, when the dot com bubble began to burst.

·       Tesla, a darling favorite of retail investors (and panned by most hedge funds) joined the S&P 500 on Monday.  It’s up 691% this year, giving it a market value of more than $600 billion and bloating its price-to-sales ratio to 22 from 3 at the beginning of 2020.

·       Options trading exploded this year as individual investors flocked to the stock market. A record number of options contracts have traded this year. An average of 29 million contracts changed hands each day this year, a 48% jump from 2019, according to data from Options Clearing Corp.  The volume for U.S. call options also hit an all-time record. The 20-day moving average of call volume just surged past 22.5 million contracts. That’s up 30% from the previous quarter and more than twice last year’s volume.

·       Citibank Panic/Euphoria Model—which factors in a number of metrics from options trading to debt—has reached the highest level since 2000 at the peak of the dot com bubble.  Citi’s Tobias Levkovich warned: “Current euphoric readings signal a 100% probability of losing money in the coming 12 months if we study historical patterns.”

·       Bank of America’s December Fund Manager Survey was the most bullish of 2020 as vaccine hopes induced a strong “buy the reopening trade.” Positioning continues its climb towards “extreme bullishness” with the BofA Bull & Bear indicator up to 6.7 (“extreme bullish” level of >8.0). Cash levels fell to 4% and triggered the FMS “sell signal.”

·       Margin debt expanded to a record $722.1 billion through November, according to the Financial Industry Regulatory Authority, topping the previous high of $668.9 billion from May 2018. If collateral falls below a certain threshold, a margin call is triggered. Margin speculators then have the option of either putting up more money or selling the securities underlying the loans.  That always exacerbates downside volatility.

·       High yield bonds have extremely low credit quality, and the yields are comparatively very low. A record number of companies have been rated CCC this year, and these are the bonds that have appreciated most in 2020.  Trying to evaluate junk bond yields and spreads  to true default risk has  been rendered a useless exercise.  

·       The volume of debt that U.S. companies have taken on this year has come to an unprecedented $2.5 trillion and has pushed the debt-to-equity ratio to record highs. The markets seem to be saying that corporate (and U.S. Treasury) debt never has to be repaid.



SOURCE:  Yardeni Research Inc.



Don’t Fight the Fed:


Fed Chair Jerome Powell said on December 16th that the Fed would keep short term interest rates at rock bottom (0 to 0.25% Fed Funds rate) and continue to buy Treasuries and mortgage-backed bonds for the foreseeable future. That amounts to a powerful tailwind for the stock market.


“You have this grand maestro up in the front that’s conducting the orchestra,” Mike Lewis, head of U.S. cash equities trading at Barclays in New York, said of the Fed’s easy money policy. “And until they stop, the music is going to continue to play.”


That quote is reminiscent of former Citigroup CEO Chuck Prince’s infamous quote in a July 2007 interview with the Financial Times. He told the FT: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing,” he said.  Please see End Quotes and last sentence of this post for more on the music still playing.


Economic Assessment and Market Outlook:


Current pandemic lockdowns and restrictions will continue.  More will likely be enacted this winter.  Consequently, adverse economic effects are likely during the 1st quarter of 2021. Moreover, the sizable monetary impulse and fiscal stimulus did not feed into the real economy.


Economic indicators, such as loan demand, are contracting again. Consumer spending is weak, household income is falling, and millions remain unemployed with unemployment insurance expiring for many. 


Yet the financial markets ignored all of the chaos and suffering of this dystopian present and are instead look forward to a utopian future.  Indeed, U.S. equities are priced for perfection and market participants are extremely bullish.


As per the B of A bullet point above, sentiment gauges across the board are recording extreme bullish sentiment, low cash ratios, and high equity exposure all at the same time. The popular opinion is that nothing can take the equity market down if a pandemic and the severest recession since the Great Depression couldn’t.


What could possibly go wrong to derail the bullish trend?  We don’t know, but as Victor has opined numerous times over the years, it will be an event(s) that the Fed can NOT control.


Bob Farrell’s rule #5:


Legendary Merrill Lynch Technical Analyst said the public buys the most at market tops and the least at the bottom.  Here’s recent proof of that maxim:  Net inflows into U.S. equity funds ballooned to $29.4 billion in the December 15th week. ETF inflows have totaled $46 billion so far in December (and that follows $81 billion of net buying activity in November).  

-->Remember that this is the same group of investors that were busy redeeming in large numbers at the March lows!


Main Street vs Wall Street:


It’s important to note that most Americans have not shared in this year’s stock market gains. About half of U.S. households do not own stock. Even among those who do, the wealthiest 10% control about 84% of the total value of U.S. equity shares, according to research by Ed Wolff, an economist at New York University who studies the net worth of American families.


As detailed in almost every news source, millions of Americans are without jobs or income, largely due to the pandemic restrictions and business shutdowns.  The Washington Post reports that they have been inundated with messages and phone calls from people on the verge of losing their homes and cars and going hungry this holiday who are stunned that President Trump and Congress cannot agree on another emergency aid package. Several broke down crying in phone interviews as they are about to be evicted from their homes.


In no uncertain terms, the year 2020 was a BEAR MARKET for humans!  But helping people get jobs, have enough food to eat and not be evicted from their residences isn’t high on the market’s list of priorities.  It’s liquidity, QE, and ultra-low interest rates that have ruled the market since March 2009.


This dichotomy between stock market investors/speculators and the rest of the population has widened income inequality to unprecedented levels and has created a whole new dimension of haves and have-nots.




The Federal Reserve’s efforts to keep interest rates at unprecedented low levels (such that real interest rates are negative across the maturity spectrum) squashed the returns available in fixed-income markets, pushing investors into equities. The central bank thereby incentivized risk-taking in financial assets (stocks, high yield bonds, bitcoin, etc.) at a time when risk aversion was not only advised but required—for everyday activities like simply going out to eat or a movie (you can’t do either of those - even outdoors- in Santa Clara, CA).


The prevailing belief is that stocks can’t go down and have somehow morphed into riskless assets —throwing caution to the wind is the way to play the market.  Haven’t we seen that sort of attitude before?


End Quotes:


“We are seeing the kind of craziness that I don’t think has been in existence, certainly not in the U.S., since the internet bubble. This is very reminiscent of what went on then,” said Ben Inker, head of asset allocation at the Boston-based money manager Grantham, Mayo, Van Otterloo.


"I do think we're at a moment in time where there's a lot of euphoria. I personally am concerned about that. I don't think in the long run that's healthy. I think it will rebalance over time as it always does," said Goldman Sachs CEO David Solomon.


“The market right now is clearly foaming at the mouth,” said Charlie McElligott, a market analyst with Nomura Securities in New York.


“The stock market is euphoric right now,” said James Angel, a Georgetown University finance professor. “A lot of people are extrapolating from the recent past and going, ‘Wow, the market’s gone up a lot and I think it’ll go up more.’ We’ve seen this play out before, and it doesn’t end well.”


B of A Chief Equity Technical Strategist Stephen Suttmeier says, “the only thing we have to fear (in the market) is perhaps the lack of fear itself.” Nonetheless, he’s bullish equities, high yield and emerging markets for 2021.


And the beat goes on…. until the music stops.                                                        



Good health, stay calm and safe, persevere under lockdowns and till next time….


The Curmudgeon

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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