Rally Brings Record Highs
The stock market is on fire as the euphoria knows no bounds. This time, stocks are mostly being led by cyclical small value stocks, but growth names have done ok too. Some investors are growing increasingly bearish on the market as there is no reason the big tech stocks should be doing this well.
Just wait until next year when the 10 year yield is at 1.5% and many of the software stocks have tough comps and declining demand. 10 year yield rose 1.1 basis points to 89.5 as it ignored the spike in cases. COVID-19 doesn’t matter to the market anymore.
Only thing that would cause angst would be a delay in the production of vaccines. Instead, we will get good news from Moderna this coming week which will boost yields even higher. There won’t be mass shutdowns, but even if there were, we can’t see it keeping yields and cyclical stocks down because everyone knows it is temporary. We are on the precipice of ending COVID-19 just as hospitalizations ramp towards a new high. It can’t come soon enough!
S&P 500 and the Russell 2000 hit record highs. This was the first new record in the small cap index since August 2018. As you can see from the chart below, the market rose 9% in the first 10 days of the month which was the best start to a month since January 1987. The stock market is extremely overbought. If stocks don’t fall by Wednesday, the AAII reading could show more bulls than its January 2018 peak. We didn’t expect a new peak so soon.
Review Of Friday’s Rally
S&P 500 rose 1.36% which put it less than 5 points above its record. That’s an amazingly slim margin. If stocks were to fall, this would still be a triple top. It was wrong to say there wouldn’t be another new record this year. Some investors are quite bearish on large caps in relation to small caps. That trade worked decently on Friday. CNN fear and greed index is only at 59 which is very low for how well stocks have done. It’s not signaling the euphoria the AAII survey is showing.
Russell 2000 was up 2.08% which put it less than 4 points above its record over 2 years ago. It has been a bad run for the small caps. That’s no return in 2 years and 2.5 months. Just having a new record doesn’t mean returns are good.
As you can see from the chart above, the enhanced value index was up over 9% this week and is up about 15% in November. This has been its best run since late May right before the peak on June 8th. There won’t be a peak like that again because we have a vaccine.
Friday was a factor day, but everything joined the party except Nio which finally crashed. Nio fell 7.7% in awe inspiring fashion. The stock fell 24% from its peak in the morning to its low in the afternoon. This stock could easily fall 30% without anything bad happening. Nasdaq was up 1.02% and the Nasdaq 100 was up 88 basis points. The latter is still 3.9% off its record high. Investors still don’t think it will hit a new record in the next few quarters.
It is dramatically overvalued with rates headed higher and demand for tech set to fall. Zoom stock fell 5.9% which put it down 29% from its peak. You could see it falling over 70% before finding a floor. It wouldn’t be surprising if the stock becomes undervalued before bottoming as euphoria turns to fear.
Small cap value index spiked 2.8% as the banks and energy did well. Regional bank index was up 3% and the oil services index was up 4.1%. Energy services index is still down 31.3% from its June peak. It’s down 55.3% year to date.
As you can see from the chart below, quite a few cyclical indexes are making new year highs on an equal weighted basis. It’s 5 of 7 of the group which includes autos, housing, transportation, consumer, financial, and small caps. Old economy stocks are doing well. Even Altria, the cigarette company, has increased 11.8% this month.
The “Impossible” Happened
Personally, I’m not a huge fan of quants because the “impossible” happens all the time and they seem to miss it. Some of their strategies work until they blow up. Imagine buying a stock that goes up 15% per year, but when it falls, it falls to 0. That reminds us of Valeant which was a hedge fund hotel. One quant’s small and mid cap strategy had an 8 standard deviation drawdown and its large cap strategy had a 3 standard deviation drawdown.
Supposedly, the crash in momentum stocks of this size is a 16 digit number followed by 63 zeros. They said this decline in momentum was statistically impossible. It's hard to believe that math, especially since t was obvious we would see growth stocks crash on vaccine news.
It was just surprising how effective the vaccine was. Turns out, the longer it takes for the data to come out, the more effective the vaccine is. A delay was apparently a good thing. That same factor means Moderna’s vaccine will likely prove very effective.
Conclusion
Value stocks have been on fire this month because of the vaccine news. Moderna’s good vaccine news probably won’t send these stocks up as much as they rose on Monday due to Pfizer’s vaccine, but they will continue to move higher.
Many don’t get why tech stocks have done so well. Zoom should be down much more on this news. The economy will reopen next year. This sounds very callous to the current situation as the virus is set to do big damage in the next few weeks. However, markets are forward looking so they are ignoring this.