Not Extremely Overbought, But Due For A Correction
The stock market is overbought. It’s not at an extreme level because the AAII sentiment and the NAAIM exposure indexes aren’t showing signs of froth. Plus, the Bank of America fund manager survey showed managers were hoarding cash. To be clear, that survey was from a couple weeks ago.
Since stocks have rallied since then, managers have since added more risk to their portfolios. Even though the stock market isn’t extremely overbought, it is near the area where it has sold off in the past few weeks ever since the first 2 explosions higher following the March low.
From April 21st to the 29th, the market rose 7.42%. It then fell 4%. Since May 13th, the market is up 6.09%. That’s a lot because each rally following minor corrections starts at a more expensive level. Each rally should be smaller. Following the recent trend, there should be a 3% to 5% correction soon. If there isn’t one, sentiment will quickly get extreme.
Remember, there hasn’t been a 3 day losing streak since early March. We have been on an amazing run. There is FOMO right now, but we’re still in a pandemic. We shouldn't expect the type of euphoria seen in early 2018 and 2020 because the economy is so bad. There is a certain limit due to reason. Besides Fed policy, nothing should cause a parabolic move up.
Anecdotal Stories
This situation feels like an extreme moment based on anecdotal evidence. Some bears have been saying this for a few weeks. They have since given up saying this which is exactly why many are now bearish. We haven’t given up. It's just that the market should correct even if good economic data comes out on a rate of change basis.
There are many stories to tell about this extreme moment on an anecdotal basis. A big story is that professional investors are now giving the Robinhood retail traders props for buying the dip at a good time. To be clear, the Robinhood traders were right. However, it takes a lot for a pro to admit that. As you can see from the table below, in Q1 E*TRADE had a 169% yearly increase in new accounts, Charles Schwab had a 58% increase, and TD Ameritrade had a 149% increase.
There is the Dave Portnoy effect in action as he is now bragging about his day trades. Penn National Gaming stock is at $29.29 which is an increase of 548% from the bottom. It’s in the sweet spot because Dave is growing in popularity and he’s getting people involved in stocks which is causing some to buy his stock.
Finally, the gambling stocks in general are doing well. Draft Kings is up 213% year to date. It rose 14.7% on Tuesday because it is considering buying the Bleacher Report. That’s a sports website which competes with Bar Stool which Dave founded.
Personally, I have seen unusual optimism. Everyone knows someone who just got into trading. My uncle went from asking me if stocks were going to zero 2 months ago to now asking me if the S&P 500 can go to 4,000 this summer. Both answers were no. To be fair, at the rate the market has rallied, it could hit 4,000 in the summer. Obviously, that’s highly unlikely. We can’t extrapolate past performance on future results.
As you can see from the chart below, most people think the stock market will recover from its bear market losses soon. Somehow 6% actually think it will take 1 month or less to recover which is more than those who said 3 years which isn’t as crazy. 69% think stocks will recover in a year or less. If you asked people that question in late March, the answers would have been much more bearish.
Review Of Tuesday’s Action
U.S. stock market was closed on Monday for Memorial Day. That was an important factor because the rest of the world rallied on Monday. And the rest of the world also rallied on Tuesday which meant the S&P 500 needed to play catch up. For most of the day, it was up big, but a late afternoon minor swoon caused it to only increase 1.23%. This was still a big move because it was yet another bear market high. Furthermore, the S&P 500 just barely closed below its 200 day moving average. This week will be important to see if it can break that limit.
Tuesday was a huge sector rotation day out of the high-flying tech stocks into the beaten down names. As you can see in the chart below, the long short value portfolio was up 4.6% which was its best day since at least 2002. Shopify stock fell 7.04% while the JETS ETF rose 11.75%. That’s the airlines. Spirit Airlines rose 21.04%.
Nasdaq was only up 17 basis points. It’s not bad if the Nasdaq isn’t down big when there is a rotation. That’s different from the rotation into tech in which the industrials and value stocks usually fall. Russell 2000 was up 2.77% as energy and the financials did well. Wells Fargo stock rose 8.65%. Best 4 sectors were the financials, industrials, real estate, and energy which rose 5.04%, 4.24%, 3.17%, and 2.91%.
Biggest winners of the past few months, healthcare and tech, were the only 2 down sectors as they fell 19 and 12 basis points. As predicted, in order for stocks to rally, previous leaders couldn’t take the reins. This sector rotation means investors are actually bullish about a return to normalcy.
Investors are awaiting a real selloff led by tech and healthcare. That might happen in the correction many see coming within the next few days. Shopify isn’t close to done with its decline. It will fall at least 30% in a real sentiment shift.