Inside The Stock Market ...trends, cross-currents, and outlook

Like many years, 2020 is one in which an investor who was armed with a perfect economic forecast would have been befuddled by stock market action. Who would have imagined that passive equity investors (including many posing as Wall Street strategists) would be so well-rewarded for ignoring the economic downturn?  

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Much of what we think “we know” about the bond market says yields should be headed higher.

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Special Purpose Acquisition Companies (SPACs) have become increasingly popular of late. We ask a seemingly simple question: “How do companies fare following a SPAC merger?”

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A truly skilled writer would attempt to build up a little suspense before revealing the central theme of this section. But in this makeshift world of sixty-game baseball schedules and seven-inning doubleheaders, who has the time or patience for that?

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Officially, those quick to pronounce the move off March lows as a new bull market have been proven correct with new S&P 500 all-time highs. Fundamentally, though, there’s enormous risk in Large Cap valuations, regardless of where one believes we are in the economic cycle.

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There’s an underlying faith that bureaucrats at the Fed and Treasury will keep good and bad businesses, alike, afloat—and overvalued. We’re still trying to unearth a single historical analog that merits such confidence.

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The most likely catalysts for improved relative performance of foreign stocks would be: (1) a bear market; (2) a recession; and, (3) a major downturn in the U.S. dollar. This year has supplied all three, yet the relative strength ratios of most foreign equity composites continue to grind lower as if it’s “business as usual.”

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The 2020 decline exhibits a strong resemblance to the “incomplete” bear market of March 2000-September 2001—in that neither decline sufficiently deflated the extreme valuations of the preceding bull, and each was followed by an immediate rebound in reliable valuation measures to top decile levels.

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In 2019 and 2020, our regard for time-tested valuation tools resulted in tactical portfolios being underexposed to stocks during a pair of tremendous rallies. Now, the critique is that we don’t appreciate the brilliance of today’s policymakers and their miraculous ability to pivot just when the stocks (and, in the latest case, the economy) need it most.

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Despite equal-weighted measures’ long-time underperformance, all valuation ratios we monitor for the median S&P 500 stock have returned to their top historical deciles. Even worse, our new equally-weighted “Valuation Composite,” based on these measures, closed August at a 98th percentile reading.

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Need more proof that we really are contrarians? While others were celebrating new all-time highs in the S&P 500 during August, we were wringing our hands over a disturbing new all-time low.

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Several measures of U.S. economic “surprises” have soared to all-time highs in the last couple of months, showing that even economic forecasters have finally learned to play the corporate game of  “under-promise then over-deliver.” Mind you, that’s only 30 years after most industrial firms eliminated the role of “staff economist.”

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The weekly covers of The Economist do a pretty good job of capturing the zeitgeist of global financial affairs, but there’s so much packed into every issue (and enough to do around our shop) that sometimes all we see are the covers. But we have to admit we’re disappointed in The Economist for the week ended July 31st. The “Free Money” theme is at least four months too late!

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The S&P 500 and NASDAQ have lately traded as if the hybrid “Fed/Treasury put” entails no cost at all. But dollar alternatives—like forex, precious metals, and crypto-currencies—are saying, “Not so fast!”

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July’s developments led to us investigate the market valuations accompanying all past month-end S&P 500 breakouts which (1) eclipsed the prior month-end bull market high; and (2) made a new all-time high in the process.

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We’re concerned that cyclical groups, which normally catch fire after a breadth thrust, are tracking along the bottom (or below) the previous worst-case outcomes following identical breadth-thrust signals.

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We get irked when TV pundits misrepresent the mood of equity investors as unduly pessimistic based one or two (or zero) data points. Among the dozens of “Attitudinal” indicators we track, an overwhelming majority show professional and retail investors have jumped back into the fray.

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As we go to press (said no one in the digital age, ever!), the S&P 500 was moving to within a couple percentage points of its February 19th all-time high. Given still-high valuations for the blue chips and increasingly frothy sentiment, we think any break above that high will be underwhelming, if not a potentially historic “trap.”

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So what do we make of July’s “low-risk” VLT BUY signal on the DJIA—the index on which the indicator’s creator (Sedge Coppock) did his original work? Sadly, not much.

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