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In our mid-month Of Special Interest, “Valuation Extremes: Here Be Dragons,” we examined valuation outliers as a measure of market sentiment. The hypothesis was that exuberance is reflected in investors’ willingness to hold stocks priced on an aggressive “vision” of the future; companies that are either habitually unprofitable or trade at a Price/Sales ratio above 15x.

Top decile valuations are often the result of unduly positive investor sentiment that leads to inflated multiples. Bullishness comes in varying strengths: optimism, enthusiasm, exuberance, and, at the extreme, the mania of crowds. Because bullishness manifests itself in aggressive valuations for speculative companies, we believe the prices being applied to such companies - for which intrinsic value is dependent on a future that looks significantly different than today - are an excellent measure of investor sentiment. In that spirit, we examined past cycles of extreme valuations with the goal of understanding how they relate to investor sentiment and what they might tell us about market conditions and relative returns.

Read this week's Major Trend.

The S&P 500 and 10-Year Treasury bond yield could accomplish something fairly rare today by closing at “joint” 52-week highs. The relevant levels to meet or exceed are 3934.83 on the S&P 500 and 1.49% on the bond yield.

Replay of a Zoom Call with Chief Investment Strategist, Jim Paulsen where he shared his thoughts and observations on today's market and what he sees looking ahead. The slides are available through the PDF Download.

Read this week's Major Trend. 

Someday, we’ll have a chuckle with our (yet unborn) basketball-playing grandson about the time Shaquille O’Neal was able to raise several-hundred-million dollars in his second SPAC. But while these anecdotes get sillier and sillier, we have a personal bias toward speculative activity we can measure over time. That activity isn’t quite as alarming as the anecdotes, but it’s getting there.

The “lower for longer” interest-rate thesis propped up the S&P 500 Low Volatility Index for more than a decade. Rising bond yields have since helped drive this former darling to an 18-year relative-strength low. Yet, assets in the S&P Low Volatility ETF are still five-times larger than its High-Beta counterpart.

Technical analysts continue to be aghast at the relentlessly “overbought” readings generated by Small Cap stock indexes. However, last month we noted that such extremes had previously presented themselves only at the early or middle phases of a Small Cap leadership cycle—never at the end of such cycles.

Equity investors have had a multi-year love affair with TINA—the belief that “There Is No Alternative” to stocks in a world of ridiculously-low interest rates. This TINA romance has carried on so long that the S&P 500 is nearing valuations last seen in the Tech bubble’s final inning. If the fling with TINA has become prohibitively expensive, we’d like to introduce “SAMARA.”

Young readers sometimes give us a not-so-subtle roll of the eyes when we discuss any sort of stock market history that occurred before their date of birth, but it takes experience to appreciate that “there’s nothing new under the sun—least of all in the stock market.”

The calendar would say the U.S. economic recovery and bull market are very young, yet there’s an astounding array of “late-cycle” activity occurring on both Main Street and Wall Street. In the manufacturing economy, bottlenecks have reached levels that have historically been troublesome for stocks.

The Fed has communicated it’s inflation target in uncharacteristically-plain English. Maybe they need to dumb it down more, because it’s the investors in English-speaking countries who have been the most surprised by the recent pickup in the inflation numbers!

The liquidity and interest-rate backdrop for stocks has been favorable to such an extreme that we’ve cautioned any minor diminution in this condition could trip up the stock market. On that score, the monetary aggregates and the Fed’s balance sheet don’t pose much concern. On the other hand...

If the “Maestro’s” image was dinged from being the “original bubble-blower,” imagine what will happen to Jay Powell’s if stock valuations mean-revert alongside interest rates and inflation over the next few years.

Twenty-one years ago, the bullish bets were on publicly-traded businesses (especially ones with dot-coms after their names). In contrast, today’s bulls seem more beguiled by bureaucrats—the central bankers who, having saved markets and the economy from catastrophe in the last year, are assumed to have mastered the business cycle.

The Reddit-driven January performance of heavily-shorted stocks reversed in February, but not nearly enough to reverse all the previous gains.

The sails have gone slack for the S&P 500’s Top-5 firms. Since the trend change at the end of August, the index has advanced 10%. As a group, the five Tech Titans have actually hindered performance during that span (-0.4% contribution).

As interest rates climb, the preference for Large Growth continues to flag. Our Royal Blue segment, the darling of 2020, is the only style box in negative territory YTD.​

The Russell 2000 has now outperformed the S&P 500 for six consecutive months. This vignette can still be used to make a relative valuation call for Small Caps over Large Caps, but the window seems to be closing quickly.