Big Monday Rally
Monday’s have almost always been positive this summer. This Monday didn’t disappoint as there was a major rally in the small caps especially. Russell 2000 was up 2.6%, while the Nasdaq and S&P 500 rose 1.87% and 1.27%. Prior to September, it was very rare for the Nasdaq to underperform small caps.
Nasdaq 100 is now underperforming to the upside after underperforming to the downside during the correction. This is much better for value investors who outperformed during the correction, but were still mad they lost money.
Specifically, small cap value stocks were up 2.14%. Small cap growth stocks were up 2.93%, proving that Monday was more about small caps doing well than value. Regional banks rallied 2.48%. Cloud stocks were up 1.8%. The only stocks that did poorly were some energy stocks.
Exxon was down 0.66% which isn’t a lot, but represents the 11th straight decline. It’s pretty rare for a stock to decline this many days in a row especially with no company specific news (just lower oil prices).
Exxon needs to cut its dividend. When it does, it's likely that the stock rallies. Tesla was up 12.58% on no news. It’s on a 4 day winning streak in which it has gained 27%. It still has a few more days to rally before Battery Day on the 22nd. Nikola was up 11.39% after it responded to the short report. However, it declined 8.13% after hours on an SEC investigation. There were also unsubstantiated rumors that GM canceled its partnership with the firm.
Speculation In Options
There has been a lot of speculation in options from retail traders and Softbank. Money is going to the high flying tech stocks. It’s causing dealers to buy the underlying which forces prices up more. Normally, stocks influence options, but there has been so much options activity, the reverse has been true.
As you can see from the chart below, the ratio of single stock options trading volume to shares volume is above 1.2 times which is way higher than it has ever been in the past 14 years. It’s about 50% higher than the peak in February.
When trying to determine the potential downside in tech, recognize that this options activity is going to cause accelerated declines. It will be even quicker than the rally this year. You can’t compare the current speculation to that of the past because there is more leverage. A decline will be fiercer than after the 1990s tech bubble and the nifty 50 bubble.
We got a glimpse of what is to come with the 10% decline in the Nasdaq being the fastest ever. We could see the Nasdaq fall 40% very quickly if greed turns to fear. The chart below shows there is a high percentage of single stock equity volume with less than 2 weeks to expiration. A quick decline in tech could cause the dominos to fall as these near term options become worthless.
Retail Traders Pull Back
As you can see from the chart below, the correction caused a big decline in small trader open call buying minus put buying. If stocks recover, the speculation will be ever higher. If you’re a long term bull, you probably don’t want to see anymore speculation. However, at least a 30% decline in the Nasdaq is almost inevitable. Giant swings in speculation usually lead to crashes, not modest corrections.
In late August, a record 62% of premiums paid for options bets on stocks rising were from people with less than or equal to 10 contracts which is almost double the long term average. This shows how much retail speculation is in the market. Options will make this crash worse than the one in the 2000s.
In the week ending September 4th, small traders bet $11.5 billion in bullish options which is 9 times the 2019 average. There was $91 billion spent on lottery tickets in all of last year.
The chart below shows the single stock options premium from small traders fell after the correction. The bottom chart shows these bets were pretty much all in the FAAMNG stocks and Tesla. Even though Facebook, Alphabet, and Microsoft aren’t in a bubble, they will fall with the rest of the bubble stocks because of this speculation.
Value Is Doing Well
Finally, value is doing well. The chart below shows the monthly performance of the Russell 1000 value versus the Russell 1000 growth index. Value index is doing over 5% better this month. That’s a huge deal because it ends the 11 month streak where growth beat value.
Furthermore, this is about to be the best month for value versus growth since March 2001. Are we about to reach the promised land for value investors? Best case scenario would be the early 2000s after the tech bubble burst.
Cyclical Upswing
A decline in stocks early in September was related to the froth in the tech sector coming off, not expected weakness in the economy. In fact, the industrials, materials, and discretionary sectors are making new relative strength highs. To be clear, this is on an equal weight basis which is important because Amazon dominates the discretionary sector.
The chart below shows the new high in the equal weight materials sector versus the equal weight Russell 1000 excluding materials. Cyclicals should continue to do well as hope surrounding vaccines, treatments, a decline in deaths/cases, and testing spikes.
Conclusion
Monday was great for the small caps. Nasdaq 100 underperformed the Russell 2000 even with the double digit rise in Tesla. Even though value has beat growth this month, there still hasn’t been a real panic for growth investors.
You don’t see Tesla rising 27% in a few days in a panic. Traders bought the dip. They will be burned every time they buy the dip in tech stocks which is the opposite of what occurred in the spring/summer rally.