Bullish Backdrop
We have the vaccine starting to go out, a $900 billion stimulus, and the Fed saying it won’t hike rates through 2023. It feels like the stock market can’t fall with such a great backdrop. Pesky tech valuations are no match for momentum and the onslaught of buying from millennial retail investors.
Many cynics claim retail investors always buy at the top, but for now they have done very well. Losses will come when retail investors double down on the bubble stocks thinking they are cheap after 20% declines.
Many fund managers bought stock in the firms that benefited from the pandemic economy because they were making a macro bet on the structural changes to the economy in the intermediate term, not because they were thinking about valuations. When they exit these stocks in mass as they face tough comps and less demand as the economy reopens, retail investors will be left holding the bag.
Sentiment Is Elevated
The only negatives facing the market are valuations, sentiment being too optimistic, and the pandemic names facing a normalized economy. We're all waiting for the reopening to hurt more SaaS stocks than speculators expect. As you can see from the chart below, the 30 day average of the put to call ratio is at a record low. Investors are very optimistic. The 4 week average of the NAAIM exposure index hit a record high. We will get another update tomorrow.
The good news is the AAII investor sentiment survey showed the percentage of bulls fell 4.6% to 43.5% which is 5.4% above average. We're not sure what to think of this metric because it showed bearishness in August when the market was extremely overbought. This market reminds me a lot of 12 months ago and 3 years ago. The short VIX correction in January 2018 could be repeated in January 2021.
The short VIX trade has been replaced with retailers being long call options. Ironically, the VIX is elevated for the amount of speculation we are seeing. The new outlet for speculation is weekly call options in speculative names.
Just like in late 2017 and early 2018, bitcoin is spiking. Bitcoin is at a record high of $22,098. It’s up 207.65% year to date. It has a market cap of $410 billion. If bitcoin and Tesla crash, that’s $1 trillion in market cap that will be wiped away.
Millennials on Robinhood have the buying power of a top 20 global hedge fund as they have $20 to $30 billion. Massachusetts is filing an administrative complaint against Robinhood because people are allowed to speculate without having prior experience.
As you can see from the screenshot below, 14,439 Massachusetts residents had zero investment experience, yet were approved for trading options. It's surprising that there are already complaints because most people are making money. Just wait for the complaints when the Nasdaq 100 crashes 30% and these bubble stocks lose 90%. This will get ugly in 2021.
Wednesday’s Action Reviewed
The S&P 500 was up 18 basis points as the Fed’s decision didn’t do much. The market is waiting for the COVID-19 stimulus to be finalized on Thursday or Friday. The Nasdaq was up 50 basis points as tech did well pushing the index higher in spite of Tesla’s drop.
Tesla fell 1.65% probably because the index fund buying hasn’t happened yet. We have been promised wild trading action this week for many weeks, yet nothing interesting has happened so far. The investment world will be watching on Thursday and Friday. It seems like all the buying will happen on Friday which could send the stock soaring.
The Russell 2000 fell 36 basis points as it was dragged lower by value stocks. Interestingly, the small cap value index fell 63 basis points even though the banks were up. The regional bank index rose 12 basis points. Energy stocks fell even though oil has done well. The oil services ETF was down 82 basis points.
As you can see from the chart below, WTI oil is now at the highest point since February. We aren’t in the negatives anymore! WTI oil will likely spend most of 2021 above $60. That’s why some think energy will be the best performer next year.
It was a great day for speculative stocks as the Nasdaq 100 was 55 basis points to a record high. It’s up 2.1% from its September peak, proving my prediction of that being a record for many years very wrong. One of the big winners in the speculative group was Shopify which rose 7.8% to a new record high. This stock is up 184% year to date. The highly shorted Carvana was up 1.9%, just missing its record high.
Baidu was up another 2.6%, putting its monthly gains at 32.3%. The Vanguard emerging markets ETF was up 55 basis points, putting it down just 2.4% from its January 2018 high. Can it break out finally? It’s interesting that the emerging market index is at the same place as that peak because we are seeing a similar amount of speculation in US stocks. One bet is that emerging markets beat the Nasdaq in 2021.
Long Small Caps?
It’s amazing how recency bias works. Fund managers are bullish on small caps after the Russell 2000 almost doubled in the shortest time ever. This isn't necessarily an amazing time to buy small caps. Instead, we can say this is a bad time to buy large caps. As you can see from the chart below, a record net 31% of fund managers think small caps will beat large caps.
Some investors have been predicting small caps to do well for a few months, so that's been right while fund managers are playing catch up. And some also don’t think the S&P 500 will have a good 2021. Beating the S&P 500 will be easy for the small caps especially since Tesla will help drag the large cap index lower.