- Once again, investor sentiment proved to be a good contrary indicator. At the depths of the market crash (late March), sentiment was overwhelmingly bearish. Since then, the market has had an amazing run (see main section). As people turned more positive on stocks, they bid share prices up to today’s levels. Where do we stand today? AAII bullish sentiment has risen but still remains below bearish sentiment. Investors Intelligence bullish sentiment has jumped significantly off the lows while bearish sentiment, which had spiked, has fallen for multiple weeks. Finally, Citigroup’s Panic/Euphoria index entered euphoria territory last week. This shift towards bullish sentiment doesn’t necessarily mean a drop is coming, but it could leave the stock market more vulnerable to bad news.
- E-commerce sales grew at over four times the rate of overall retail sales in 2019 and now account for 11% of total retail sales. This rapid growth in online shopping may even accelerate further due to the impact of Covid-19. Meanwhile, the erosion of brick-and-mortar stores continues, and major household names are declaring bankruptcy. In 2019, over 9,300 retail stores closed their doors – a 59% increase from 2018. This year analysts are expecting 15,000 stores to close permanently and 100,000 over the next five years – more than triple the number that shut during the previous recession. Disruptive secular trends were in place long before the pandemic hit, and they are likely to remain deep-rooted long after it has passed.
THE MASSIVE MELT-UP RALLY
The market has had a huge run, which seems to make little sense. The S&P 500 is stuck between two competing forces, although the ‘bid’ has been winning. On the one hand, there is $6 trillion of central-bank asset purchases globally. On the other hand, global earnings for 2020 could show a 50% drop. In short, we agree with the perception that the Fed is boosting asset prices, but think the market is placing excessive confidence in the Fed’s abilities.
The 30%+ rally in the S&P 500 off its March low has been extraordinary and unexpected. The price rise has now pushed valuation levels past the February pre-pandemic peak. The Fed has been able to inflate asset prices, but they have never sustainably sent multiples this high. Valuations at these levels (based on peak earnings) have always been followed by lower prices. The most common argument for high prices is low-interest rates. We agree that prices/valuations should be above average due to low rates, all else equal. But all else is not equal. Today’s ultra-low rates are based on an economy that is far from the solid fundamentals we were seeing just a few months ago.
The two-month rally we have seen is the equivalent of over three years of good market (historical) returns. Clearly the pace of gains won’t continue. But will we stay at these elevated levels until the haze of normalization becomes clearer, or do we trade down from here adding back a risk premium for something that can’t be predicted? Of course, no one knows the answer to that but to us the market is now pricing in a perfectly shaped ‘V’ recovery, still an unlikely outcome in our view.
With data changing daily, all eyes will be on the pace of normalization. Increased viral spread is one concern, but also the threat that consumption and employment do not normalize as fast as social restrictions is another key worry. There will likely be green shoots among horrendous headlines. Given the uncertainty amidst high valuations, we remain skeptical that prices can stay at these lofty levels.