A Harrowing Friday – Momentum Stocks Continue to Break Down

The release of Friday’s payrolls report was the worst of all worlds for the US stock market. This typically happens in bear markets: suddenly fundamental data that wouldn’t have bothered anyone a few months ago are seen as a huge problem. Why was it seen as problematic?

The report somehow managed to be weak and strong at the same time – it showed weakness in payrolls growth, but the entirely artificial U3 unemployment rate, which is distorted by the fact that a huge number of unemployed are no longer counted as unemployed, but rather as simply having “left the labor force”, fell below 5% at the same time.

 

0715_socialmedia_630x420Photo credit: Mike Kemp / Getty Images

 

This fact should keep the labor market-focused Keynesian leadership of the Fed (primarily Ms. Yellen herself) from moving very swiftly toward a loosening stance – although everybody knows this is what will eventually happen anyway. Does it actually matter? Not in reality, but it certainly matters to an already frayed market psychology.

If there is one chart that describes best that the US stock market has a really big problem now, it is probably this one:

 

1-NDX-SPX ratioThe ratio of the Nasdaq 100 Index to the S&P 500 Index. The Nasdaq, which is primarily driven by big cap tech stocks was the one leading sector that still managed to hold things together while market internals deteriorated throughout 2015. Now its relative strength is beginning to break down as well – click to enlarge.

 

As we have pointed out previously, the same thing has of course happened quite some time ago to other sectors that have been leading the bull market from the 2009 low. Here is a longer term chart showing two of them – small caps and transportation stocks – relative to the S&P 500:

 

2-RUT-SPX and TRAN-SPXThe RUT peaked against the SPX in early 2014, the Transportation Average in late 2014´ – click to enlarge.

 

On Friday traders were rudely reminded of the fact that overvalued momentum stocks can actually go down as well as up – and they can do so quite violently. In the “social media” sub-bubble, companies are competing for people’s time. Since the day only has 24 hours, there are just so many things people can focus on – and it seems obvious that some of the companies competing for people’s attention and time will have to lose out in this contest, or will find that the pie they are competing for does actually not provide unlimited growth opportunities for all contestants. Shareholders in LNKD (Linked-In) received a harshly worded memo on Friday, so to speak:

 

3-LNKDLNKD lost 43% or $11 billion of its market cap on Friday – click to enlarge.

 

Numerous momentum stocks that are vastly over-represented in nearly every hedge fund and mutual fund portfolio (including the one run by that famous hedge fund in the Swiss Alps, the SNB) have broken important uptrend lines on a daily basis and in some cases on a weekly basis as well. Here are three prominent examples:

 

4-Momentum StocksAMZN, TSLA and NFLX – three favorite momentum stocks have broken their uptrends rather decisively – click to enlarge.

 

We could have added many more stocks to this list of course – for instance, the biotech sub-bubble has been deflating rather quickly as well in recent months (it is under pressure since last summer in fact), but the above should suffice to get the point across: the final piece of the longer term puzzle has fallen into place, as it always does at these junctures.

The most egregiously overvalued “story stocks” always tend to have enormous blow-off moves at the end of an advance, while concurrently more and more market sectors are already entering bearish trends. They are thus always the very last stocks to peak. Once they do top out and begin to turn down decisively, it suddenly becomes clear to everyone that the market regime has turned from a bullish to a bearish one.

At the eventual bottom, something similar will happen, only vice versa: these stocks will very likely make a higher low while the rest of the market falls to a new low – this always seems to happen as well. But that is a discussion for another day.

 

Shades of 2000 Revisited

We already suspected in mid 2013 (worrying about the market far too early as it has turned out in hindsight) that there were parallels to what happened in the late 1990s bull market, specifically near its end in the year 2000.

However, in the meantime, even more such parallels have become noticeable. We hasten to add that today’s fundamental backdrop is very different in many respects, but there are also many noteworthy similarities (the most glaring one consists of extremely low commodity prices and rolling crisis conditions in emerging markets and their currencies). Here is a paraphrase of what we wrote in reply to a friend who wondered in what ways exactly we would describe the environment as similar:

In 2000 tech stocks went to the moon and value stocks were greatly depressed – we still remember the Tiger fund giving up in disgust a few weeks before its bets would actually have begun to work out. Of course there is no guarantee such parallels will continue, but they probably will for a while.

We have kept close watch on the gold sector and chronicled what has been happening there in these pages in recent months. We have just seen a strange deja vu there: the Rand implodes, and gold in rand streaks to a new all time high, taking the previously extremely depressed South African gold stocks up with it. Shortly thereafter, gold in USD terms begins to rise – which is what happened in 2000/2001 as well.

At the same time, we have seen the tech sector vastly outperforming in 2015, on the back of fewer and fewer big cap stocks – which is also very similar to what happened in 2000. Before the tech mania peaked in 2000, junk bond yields had been rising for well over a year already – just as has happened recently.

 

5-Wilshire vs. Junk yields turn of the centuryJunk bond yields vs. stocks in the late 1990s – another strong similarity to what has happened recently – click to enlarge.

 

But wasn’t the mania of the late 1990s very different in terms of public enthusiasm and retail participation? It certainly was – here is how we would assess “then vs. now” with respect to this:

The late 1990s run-up was a mania that had great similarities to the 1920s bubble. Since then, the public has experienced two bear markets in just 15 years that have been among the four worst in history. So the public enthusiasm that prevailed in the late 1990s no longer exists – rather, as Bob Prechter has put it, we have experienced a “bull market with depressionary undertones“.

The year 2000 seems to have established the biggest extremes ever valuation-wise, but not in terms of the median stock. In terms of the median stock’s P/E ratio (i.e., leaving aside the skew of index valuations based on market cap weightings), as well as in terms of price/sales, the US stock market has never been more overvalued than in 2015.

One also has to consider that in spite of the apparent lack of public enthusiasm, people are just as, or even more exposed to the stock market today as they were then. According to Ned Davis, as of mid 2015 US household exposure to the stock market was at its third-highest level since 1952. It was only slightly higher in 2000 and 2007.

Below are updates of three long term positioning/exposure charts we have posted several times in the past: in terms of margin debt, the mutual fund cash-to-assets ratio and the ratio of retail money market fund assets to the market capitalization of the S&P 500 Index, the public’s stock market exposure – both directly and indirectly – has never been greater than it was last year:

 

6-Margin DebtNYSE margin debt has risen to a record high and has begun to decline from there in recent months – click to enlarge.

 

7-Mutual fund cashThe mutual fund cash vs. assets currently stands at a record low of 3.2% – it stood at 4.4% at the peak of the tech bubble in 2000 – click to enlarge.

 

8-Retail money fund ratioRetail money market fund assets relative to the market capitalization of the S&P 500 have never been lower than in the period 2012-2016 – click to enlarge.

 

As you can see from the above, these long term positioning and sentiment indicators continue to indicate that the stock market harbors enormous risk and that its downside potential in the long term is huge. This will remain true even if the current bout of weakness is reversed and the market rallies one more time.

 

Short Term Outlook

In the short term the market is becoming quite oversold. Based on current shorter term positioning indicators and the history of past bear markets that have started out with an especially weak January performance – which we have recently discussed (see The Stock Market Suffers the Worst Start to the Year Ever for details) one would expect that a rebound will soon begin, after perhaps after a few more days of weakness. The market should then establish a lower high sometime in the March-May time frame.

This is currently suggested by high and rising equity put-call ratios and large small speculator net short positions in stock index futures. Both may still have room to rise even further in the short term, but they are closing in on levels that have marked short to medium term lows in the past:

 

9-CPCEThe equity put-call volume ratio: at 0.92 it is already quite high historically, but there is still room for a further short term spike – click to enlarge.

 

As Jason Goepfert has suggested in a recent interview at King World News, futures positioning also seems to suggest that the bearishness of traders has become a bit too pronounced in the short term:

 

10-SentimenTrader-I-252016-1-1024x719The small speculator net short position in stock index futures has grown to quite extreme levels recently – click to enlarge.

 

However, both the market’s poor internals and the still very low VIX indicate to us that caution remains warranted over coming days:

 

11-VIXThe VIX still remains too low… – click to enlarge.

 

A Major Caveat: Elevated Crash Risk

Here are a few caveats regarding the short term outlook: after China reported over the weekend that there was another outflow of nearly $100 billion from its foreign exchange reserves in January, markets are understandably rattled. Here is a chart from the WSJ illustrating the situation:

 

12-China ReservesChina’s foireign exchange reserves continue to decline rapidly, which suggests that a further devaluation of the yuan is ever more likely.

 

In a recent letter to Eclectica investors, famous hedge fund manager Hugh Hendry made the following remark in this context – he thinks China will refrain from devaluing its currency further:

 

“China would quite rightly be considered a pariah and its policy makers must surely expect a huge increase in trade tariffs and competitive devaluations from other countries. Everyone would lose.”

 

We are astonished what a crucial mistake in thinking Hendry is falling prey to here. For one thing, he seems to assume that China’s central planners have these events under control (and from his conversion to a bull not very far from the peak of the bull market he seems to think the same of other central planners – see “Hugh Hendry and the Blue Pill” for details on this).

Well, they don’t. There is a big difference between “having enormous influence on the markets and the economy” and “having control over them”. No-one controls the laws of economics or truly controls the markets. Hasn’t the downturn in China’s stock market just demonstrated this principle?

Secondly, he also seems to assume that China’s leaders are perfectly rational. One simply cannot assume that they are – in fact, we are certain that they are not. Very similar arguments were made just before World War I – many people looked at global trade (which was flowering at the time) and the economic interdependence it had created and concluded that “there can be no war, because everybody would lose”. They were right about one thing: Everybody did lose. But there was a war anyway, because human beings do not always act rationally.

Moreover, extremes in positioning and sentiment data have become far less reliable as contrary indicators in recent years – this quite likely due to the fact that a lot more automated trading based on predetermined rules takes place these days.

The combination of huge open interest in options relative to share trading volume and the prevalence of black box trading systems and HFT are bound to create far greater volatility – especially now that the period of “stealth deterioration” in market internals has been replaced by a more obvious, general deterioration in technical conditions. In other words, crash risk remains elevated.

 

Conclusion

Our “standard expectation” would be that the market suffers a little more near term weakness and then rebounds to a lower high in the March to May time frame. However, nowadays one can no longer blithely rely on “oversold” signals to necessarily stop very persistent trends. We have seen this time and again in currencies and commodities in recent years.

Moreover, all the long term indicators we follow continue to indicate that market risk remains extremely high. In many ways today’s situation is reminiscent of the previous bubble peak in the year 2000. We would say that the major difference between then and now in terms of investor behavior is that the late 1990s bubble was mainly driven by retail investors, whereas Ben Bernanke’s echo bubble was mainly driven by professional investors.

Since the broad true US money supply TMS-2 has expanded by 119% since 2008 and by precisely 300% since 2000, we need not discuss whether or not it is a bubble – it most definitely is one. The only questions are whether it is actually truly over (like the proverbial cat, it may still have another life left), and if so, how big the denouement will become and how precisely it will play out.

 

Charts by: StockCharts, SentimenTrader, St. Louis Federal Reserve Research, WSJ

 

 
 

Emigrate While You Can... Learn More

 
 

 
 

Dear Readers!

It is that time of the year again – our semi-annual funding drive begins today. Give us a little hand in offsetting the costs of running this blog, as advertising revenue alone is insufficient. You can help us reach our modest funding goal by donating either via paypal or bitcoin. Those of you who have made a ton of money based on some of the things we have said in these pages (we actually made a few good calls lately!), please feel free to up your donations accordingly (we are sorry if you have followed one of our bad calls. This is of course your own fault). Other than that, we can only repeat that donations to this site are apt to secure many benefits. These range from sound sleep, to children including you in their songs, to the potential of obtaining privileges in the afterlife (the latter cannot be guaranteed, but it seems highly likely). As always, we are greatly honored by your readership and hope that our special mixture of entertainment and education is adding a little value to your life!

   

Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke

   
 

One Response to “The Bubble Deflates – And Crash Risk Rises”

  • JohnnyZ:

    I have met Hugh Hendry recently. I consider him now a broken portfolio manager. He used to be out-of-the-box, out-of-consensus thinker, but this caused his performance during the latest bubble episode to suffer. I think he was not wrong, but early. But he came to the conclusion that his thinking was wrong and his most important objective was and is to survive as a money allocator, so he changed his thinking. He suffers from some post-traumatic bias (e.g. “everything is controllable by the central banks” disorder). His performance has been okay-ish recently, but he must be hurt (maybe not disproportionately) by the bubble burst now. He prefers to make money and not be right, so he will probably be quite wrong now at times.

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • factoryA Striking Chart
      The Economy and the Stock Market As long time readers know, we are always paying close attention to the manufacturing sector, which is far more important to the US economy than is generally believed. In terms of gross output it is the largest sector of the economy, and it should of course be obvious that saving, investment and production are the only ways to create wealth.   What's left of the Brooklyn Domino Sugar Refinery. Photo credit: Paul Raphaelson   Contrary...
  • trump-putin-1024Trump and Putin Narrowly Escape Assassination Attempt
      The Gloves are Coming Off First a little bit of recent history. Readers are probably aware that some questions about the occasionally malfunctioning Deep State android... no, wait, we'll start again. Questions have recently been raised about the health of presidential candidate Hillary Clinton by various “alt-right” tinfoil hat-wearing conspiracy theorists, such as this one.   The monsters are normally hiding under Hillary's bed, but lately they have come out into the open...
  • historical-photos-pt9-pepsi-factory-baltimore-1956-aUS Economy - Curious Pattern in ISM Readings
      Head Fake Theory Confirmed? This is a brief update on our last overview of economic data. Although we briefly discussed employment as well, the overview was as usual mainly focused on manufacturing, which is the largest sector of the economy by gross output.   Pepsi factory in Baltimore, 1956 Photo via pinterest.com   Readers may recall that we have pointed out for some time that there was quite a large gap between the data reported in regional Fed manufacturing...
  • escobarA Convocation of Interventionists, Part 2
      Pleas for More Deficit Spending We continue with our Jackson Hole post mortem – including remarks that were made by economists and monetary bureaucrats shortly before and after the pow-wow and seem to be connected to the discussions there.   Assembled central planners (we're not sure if this picture was taken at the conference, but most of the people in it were there). Photo credit: Getty Images   We should preface the following with a Mises quote, as the...
  • swing-voterWhy the Fed Destroyed the Market Economy
      What Have You Done for Me Lately? Swing voters are a fickle bunch.  One election they vote Democrat.  The next they vote Republican. For they have no particular ideology or political philosophy to base their judgment upon.   The primacy of the wallet.   They don’t give a rip about questions of small government or big government.  Nor do they have any druthers about the welfare or warfare state. In effect, they really don’t care.  What’s important to the...
  • time-wastersHow is Real Wealth Created?
      An Abrupt Drop Let’s turn back to our regular beat: the U.S. economy and its capital markets. We’ve been warning that the Fed would never make any substantial increase to interest rates. Not willingly, at least.   Groping in the dark, Yellen-style   Each time Fed chief Janet Yellen opens her mouth, out comes a hint that more rate hikes might be coming. But each time, it turns out that the economy is not as robust as she had believed... and that a rate hike isn’t...
  • wallet-367975_960_720Janet Yellen’s Shame
      Playing Politics In honest capitalism, you do what you can to get other people to voluntarily give you money. This usually involves providing goods or services they think are worth the price. You may get a little wild and crazy from time to time, but you are always called to order by your customers.   In the market economy, consumers reign supreme. There is no such thing as a “lost” vote in the marketplace; every penny spent affects production. Mises noted: “Consumers...
  • warren-buffett-gold-coinGet Ready for a New Crisis – in Corporate Debt
      Imposter Dollar OUZILLY, France – We’re going back to basics here at the Diary. We’re getting everyone on the same page... learning together... connecting the dots... trying to figure out what is going on.   The new three dollar bill issued by the Apprehensive States of America.   We made a breakthrough when we identified the source of so many of today’s bizarre and grotesque trends. It’s the money – the new post-1971 dollar. This new dollar is green. You...
  • central bank HQs 2A Convocation of Interventionists – Part 1
      Modern Economics -  It's All About Central Planning We are hereby delivering a somewhat belated comment on the meeting of monetary central planners and their courtier economists at Jackson Hole. Luckily timing is not really an issue in this context.   Central bank headquarters: the Fed's Eccles building, the ECB's hideously expensive new tower in Frankfurt, and the BOJ's Tokyo HQ (judging from the people in the foreground, it may be a source of noxious fumes).   When...
  • silkroadHanjin Marooning in San Pedro Bay
      Global Trade Reversal Expansions and contractions in global trade have played out over long secular trends for thousands of years.  The Silk Road, for example, was established by the Han Dynasty of China in 130 BC, and allowed for continuous trade between East and West for nearly 1,600 years.  In addition to economic trade, the Silk Road was also a conduit for culture and knowledge among its network of civilizations.   A map of the main ancient Silk Road - click to...
  • SamuelsonJohn Maynard Keynes’ General Theory Eighty Years Later
      The “Scientific” Fig Leaf for Statism and Interventionism To the economic and political detriment of the Western world and those economies beyond which have adopted its precepts, 2016 marks the eightieth anniversary of the publication of one of, if not, the most influential economics books ever penned, John Maynard Keynes’ The General Theory of Employment, Interest and Money.   The mere fact that the book is lauded by TIME magazine on the cover should give everyone...
  • 4-ip-and-non-def-capital-goods-ordersThe Economy, the Stock Market and the Fed
      John Hussman on Recent Developments We always look forward to John Hussman's weekly missive on the markets. Some people say that he is a “permabear”, but we don't think that is a fair characterization. He is rightly wary of the stock market's historically extremely high valuation and the loose monetary policy driving the surge in asset prices.   The S&P 500 Index and the NYSE advance-decline line. Most market internals weakened steadily until early February 2016, but...

Austrian Theory and Investment

Support Acting Man

Own physical gold and silver outside a bank

Archive

j9TJzzN

350x200

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com