Are We Headed Back to The Dark Ages???
Many investors, myself included, have been sitting around and wondering what in the hell has been going on with cyclical/value stocks this December.
Most market participants look at the massive divergence between breadth (more stocks declining than rising in each of the past 11 trading sessions) and indices, which are hitting fresh all-time highs, and come away with a worrying message.
And for those who subscribe to the Stan Druckenmiller school of markets – we should be terrified of this message. Here’s what I mean…
Stan Druckenmiller is famous for watching the internals of the stock market to glean insights about the economy. A popular quote of his goes as follows, “The only good economist I have found is the stock market. To people who say it has predicted seven out of the last four recessions, or whatever, my response is that it’s still a lot better than any of the other economists I know.”
What he means by this is that the performance of stocks within certain sectors or industries tends to give a reliable lead on future economic activity.
So, let me paint you a picture.
Sources: TradingView, Game of Trades
The thing is, conventional wisdom says that whenever the 10-year/3-month yield curve dis-inverts, it typically means a recession is right around the corner. In fact, it’s the only indicator that has a 100% success rate with calling recessions.
What just happened? The 10-year/3-month curve dis-inverted on December 9, 2024.
Let me add a bit more color… ‘Value’ stocks have recently traded lower for a record-setting 11 consecutive days – something Stan fans would say is a worrying sign of things to come.
But wait, there’s more – a whole lot more…
I’m about to run through a series of graphics to give a better sense of the current set-up for equity markets.
On November 4, 2024, Bloomberg made the brilliant observation that “Unbeatable US Stocks Leave Diversifiers in the Dust.” In its article, the columnists went on to pose the question, “Why Not Invest 100% in Stocks?”
Not typically something you hear at the start of a major bull market…
Around the same time, a popular research provider named SentimenTrader published a study to demonstrate the insane flows into levered bullish products.
Source: SentimenTrader
Again, not something you see at the start of a major bull market…
The Economist, not to be outdone on the Stupidity Meter by any publication, followed this up with their own story which read, Should Investors Just Give Up on Stocks Outside America?
Source: The Economist
We have the likes of Walmart (WMT), you know, the boring old consumer staple company selling everyday basic goods, trading at 40x earnings. Costco (COST), the bulk provider of similar products trading at 58x earnings.
I mean, did these big box stores suddenly discover some new weight loss pill that dwarfs the efficacy of Ozempic?!
Now, you’re starting to see why The Economist question registers so high on the Stupidity Meter…
Apple Inc (AAPL) is trading at 10x sales. Paging Scott McNealy (CEO of Sun Microsystems) from the Dot Com era…
“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”
For the S&P 500 Index, as a whole, we are now trading at a higher price-to-book multiple than the peak of the Dot Com bubble.
Don’t like price-to-book? Fine. The S&P 500 Index now trades at a price-to-sales multiple that is ~35% higher than the peak of the Dot Com bubble.
Source: Bloomberg
Michael Saylor, yes, the one who was charged by the SEC in March of 2000 for fraudulent reporting of financial results, has apparently invented an ‘infinite money glitch.’
In fact, some point to Saylor being charged as one of the lynchpins to the bursting of the Dot Com bubble. Wouldn’t that be something if he managed to do it again with the addition of his company MicroStrategy (MSTR) to the NASDAQ 100 here in December 2024?
I mean, what could go wrong with this strategy? Sell debt and stock, buy bitcoin with the proceeds, price of bitcoin goes up so stock price goes up, sell more stock and debt, buy more bitcoin with new proceeds, price of bitcoin goes up more, stock price goes up more, and on and on and on.
See? I told you it was an infinite money glitch!!!
The meme cryptocurrency Fartcoin – closing in on $1 billion – now has a market cap larger than the vast majority of publicly-listed US stocks.
Permabears David Rosenberg, Mike Wilson and Nassim Taleb have all thrown in the towel as they concede that there’s no stopping this bull run.
‘Quantum Computing’ headlines are dominating the air waves as stocks with $37 million in revenue, -$172illion in net losses, and -$114 million in operating cash flows are trading for >$9 billion in market cap.
Do you know when we hear of ‘quantum computing’ breakthroughs? I’ll give you a hint…
“Scientists make seven-bit quantum leap in computer research” – March 29, 2000
“Multiverse Computing Partners with IonQ to Bring Quantum Computing to Global Finance” – November 11, 2021
“IBM Unveils ‘Eagle’ Quantum Computer Processors” – November 16, 2021
“Google Says Its Quantum Chip May Prove Parallel Universes Exist” – 12/11/2024
Do any of these dates ring a bell? Were they not when equity valuations were at their absolute peaks in all of history? Were they not at a time when hype after hype was being sold to gullible “investors”?
I mean, seriously, Google is proving that parallel universes exist?! They’re not even pretending to respect our intellectual capabilities anymore…
BlackRock has proclaimed that the Boom & Bust cycle of the economy no longer exists. Calling Irving Fisher – “Stock prices have reached what looks like a permanently high plateau” – just nine days before the Wall Street Crash of 1929.
Meanwhile, corporate insiders and Warren Buffett both seem to see the writing on the wall. Buffett now holds ~28% of its total value in cash – its highest level since at least 1990.
The Corporate Insider Ratio of Sellers to Buyers has also hit a fresh all-time high…
Source: Financial Times
Granted, neither one of these tend to time the market with any sort of short-term precision, but it should serve as a warning nonetheless.
On the flipside of these, let’s just call “rational actors”, we have the psychos running the asylum.
Equity allocations have surged to the highest on record…
Cash allocations have fallen to the lowest on record…
Everyone wants equities and Bitcoin, while no one wants cash or bonds…
And when I say everyone, I don’t just mean “Fund Managers” from the Bank of America survey…
Consumers are now the most bullish on record and by a wide margin…
Source: Bianco Research
Asset managers are running close to an all-time record high in long exposure to S&P 500 Index futures (just below the January 2020 peak).
Any way you slice it, this market is down-right euphoric. Manic. Crazed. Greedy. Reckless. Absurd. Stupid. I honestly can’t think of enough adjectives to describe what we’re seeing in today’s market.
And this is only a sliver of the evidence – both statistical and anecdotal – that points to the level of stupidity we’ve reached today.
So, let me tie all this back into my original question of, “Are we headed back to the Dark Ages?”
If things were so amazing, why have ‘value’ stocks fallen for 11 consecutive trading days? Note – at the time of this writing on December 17, 2024, we’re on pace to make it a 12th consecutive day. Are the internals of the stock market telling us that Warren Buffett and all those corporate insiders might be onto something?
My gut tells me, yes. And all that I’ve laid out above is plenty enough for people to be extremely cautious as we head into 2025. But let me pose one other theory as to what might be driving such a dramatic divergence – one that might not set off the alarm bells…
Source: Strom Capital Management LLC, TradingView
Here’s a 10-minute chart of the iShares S&P 500 Value ETF (IVE) in red, compared to mega cap Tech stocks such as Alphabet (GOOG) in black, Tesla Inc. (TSLA) in light purple, Apple Inc. (AAPL) in dark purple, and Amazon.com, Inc. (AMZN) in green.
Notice anything about the start of December when all of those colored lines really began to generate strong upside momentum? What happened to value (red line)? It started to drop. The action wasn’t panicky, just a steady bleed lower, almost as if some major institutions were running large ‘sell programs’ to get out of value stocks. The same can be said for the steady grind higher in those Tech names.
What makes this even more bizarre is the backup in interest rates over this same time period as value and rates tend to be positively correlated (rising rates tend to indicate stronger expectations for economic growth and thus value stocks perform well).
Why is this happening?
Leading up to and immediately after the election, investors loaded up on banks, industrials, materials, energy, transports – the classic “Trump Trade 2.0”.
After the election, this worked for a few days. However, once we turned to December and those major Tech names (not in the Trump Trade 2.0 playbook) started to generate upside momentum, year-end performance chasing went into full effect.
Year-end bonuses, performance reviews, client conversations, you name it, are all based on how you performed versus the market. How could you, as a portfolio manager, be overweight equities but still lag so far behind the market as it melts higher?
Now, we just went through an entire backstory of how investors hold virtually no cash. So, in order to get cash to chase the accelerating momentum, investors have been forced to dump what they were previously overweight (banks, industrials, transports, materials, etc.). And, yes, this could also be why bonds have not been able to find any bid despite the supposed deterioration in market internals.
Are we headed back to the Dark Ages? I mean, come on, don’t be ridiculous. There are plenty of reasons to be extremely cautious of the current market, none better than the simple fact that there appears to be no fear at all.
The pitiful nature of the 2022 “bear market”, and its subsequent rebound back to euphoric levels, has most investors believing that invincibility is an actual thing.
My point in this whole discussion was merely to lay out that, yes, weak forward returns for the equity market seems probable. But the belief that a crash is imminent, based off the recent weakness in ‘value’ stocks, might be a bit premature. Year-end flows always play a major part in the performance of various asset classes (tax loss, deferring cap gains, performance chasing, etc.).
What can we do? De-risking is naturally one option. But positioning for a corrective rotation isn’t the worst of ideas, either. Maybe that comes after December OPEX (December 20, 2024). Or perhaps it isn’t until January of 2025.
All I know is that we either see a significant rotation in short order or perhaps it is time to start running for the hills…