Stocks Stay Overbought
Stocks were on their way to another solid day, but they fell in the afternoon; the rally in the last few minutes of the session didn’t cancel out all the losses. Alas, the Nasdaq wasn’t able to hit a record high for 11 straight days. That would have been the longest such streak since 1987. Instead it fell 17 basis points.
S&P 500 was flat and the Russell 2000 fell 0.51%. Small cap index is now on a 2 day losing streak. Even though the S&P 500 was technically barely positive, the VIX rose 0.78 to 13.43 because of the selloff in the afternoon. It certainly wasn’t a big selloff worth reviewing in detail. Any sort of decline has become exceedingly rare.
As of Thursday’s close the S&P 500’s 14 day RSI hit 77.37 which is the highest level since January 2018. Many strongly believe a 5% to 10% correction is coming in January 2020 as stocks are very overbought. This correction will be before earnings season unlike the one in 2018. In January 2018, the 14 day RSI hit the low 80s.
A decline late in the month wasn’t about earnings season. It just happened to occur at that time of year. Even firms that reported good numbers saw their stocks decline. That was a great time to find value in the midst of the rubble. You got to buy stocks at a discount after they did well. Usually, you need to pay extra to find out positive information about companies. In other words, your potential gains decline when a stock rises after telling you how good business has been.
Valuations & Recent Action Matter
Including dividends, the S&P 500 has returned 32% for investors in 2019. That’s the 18th such gain since 1928. It’s not such a rare occurrence. Stocks aren’t overbought because of their year to date performance. They are overbought because of their rally in the past few weeks. Secondly, not all great years lead to stocks being expensive. That’s why stocks tend to rally after big years like this one. However, this year earnings growth was slightly positive, so it’s unusual.
It’s very lazy to assume stocks will follow their average returns following years with high percentage gains. To be fair, it’s also lazy to recommend selling stocks after a good year. That mistaken logic is the main reason such analysis on how stocks do after rallies exists. It’s not a great idea to buy stocks with a slightly above 18 PE multiple unless you expect strong earnings growth. Personally, I expect stocks to rise less than earnings do which means even with high single digit EPS growth, it won’t be a great year.
A Few Stats On Why Stocks Are Due For A Correction
There are 9% fewer bears than normal and 3.9% more bulls. The difference between bulls and bears is in the 90th percentile. If you look at only this signal to determine when to sell stocks, it won’t work well because only 8 of 49 signals were successful since 2009. That’s why I like to look at the AAII survey as only part of the sentiment picture. There are other data points to review. CNN fear and greed index fell 2 points to 91 which is still extreme greed.
According to Sentiment Trader, on Christmas Eve 2018, 54% of their core indicators showed extreme pessimism. As of Thursday, 55% showed extreme optimism which is the highest percentage in 15 years. The search volume of the term “melt up” is the highest ever. I don’t think that alone is enough of a reason to sell stocks. But it adds to all the negatives previously mentioned. Finally, as you can see from the chart below, the NDR trading sentiment index is at 86.67 out of 100 which is one of the highest readings in the past 14 years. When the index has been above 62.5, the annual loss has been 7.77% since 1994 and 5.44% since 2006.
Other Action In Markets
Worst sector on Friday was energy which fell 0.47%. Best 2 sectors were real estate and consumer staples which rose 0.35% and 0.4%. Finally, Apple stock didn’t rally as it fell 4 basis points. It’s still unusually expensive which is partially why I think it will underperform in 2020. It’s my favorite short.
As you can see from the chart below, Apple’s PE multiple is the closest to the S&P 500’s multiple in 7 years. It’s no surprise its huge rally has been due to multiple expansion. The stock usually trades at a discount to the market because it sells hardware. Usually, it’s very difficult to drive repeat business and raise prices in hardware. Apple’s shift to services justifies some of this multiple expansion, but not all of it. It still relies on iPhone sales even though the firm doesn’t want to admit it because smartphone sales have been falling.
Update On Democrat Primary
There weren’t any new polls released on Thursday or Friday, but there was news on Warren’s donations which is interesting. Warren raised $24.6 million in Q3. She only raised slightly over $17 million in Q4. In Q3, she was in 2nd place as Sanders raised over $25 million. That was a good quarter for her as she was rising in the polls and raised more money than Buttigieg and Biden. This 30% decline in Q4 shouldn’t be a shock because of all the momentum she has lost in the polls.
I’m guessing Sanders raised the most again this quarter. Warren may have fallen behind Biden and Buttigieg. Her odds in the PredictIt betting market fell 1 point to just 12% on Friday. That’s her lowest percentage in the past 90 days.
Her and Pete’s loss of momentum have helped Sanders modestly in the polls and significantly in the betting markets. He now has a 40% chance of winning Iowa which is up from 25% on December 1st. He has a 50% chance of winning New Hampshire which is up from 36% on December 1st. If he wins both states, he will have a great deal of momentum. He has the best shot at beating Biden as of today.