December 14-17, 2020: market thoughts

The following is my stream of thoughts for the week December 14-17. This blog post will be continuously updated throughout the week with new thoughts.

December 15, 2020

Wall Street Strategists

As Bloomberg noted, the average Wall Street strategist expects the S&P 500 to gain 10% next year. While expectations of such gains are common in a year when stocks crashed (strategists expect stocks to bounce back next year), they are uncommon when stocks did well this year. In other words, Wall Street strategists are chasing the rally right now and predicting that it will continue.

Their track record is poor.

There were only 5 other years in which analysts expected the S&P to rally >5% while the S&P was close to a 1 year high (i.e. analysts weren’t bullish simply because they were expecting a post-crash rally).

  1. December 2006: the bull market ended in 2007
  2. December 2007: massive bear market in 2008
  3. December 2014: stocks tanked in August 2015
  4. December 2015: stocks tanked immediately in January 2016
  5. December 2017: stocks experienced heavy volatility in 2018, with a crash in Q4 2018
  6. Now

This is not a good sign for stocks next year. Perhaps analysts feel optimistic because IPO’s are booming like it’s 1999?

Financial Stress

Stocks and commodities have done well this year, thanks to ample Fed support. The worst recession in a century has been followed by extremely easy financial conditions. The following chart illustrates the Westpac U.S. Financial Stress Index, which is back to where it was during the December 2019 – January 2020 melt-up:

*The U.S. Financial Stress Index is calculated by averaging 7 variables: bank sector beta, the Ted spread, yield curve, corporate bond spread, stock market returns, stock market volatility, and exchange rate volatility

When financial stress dropped 6 months in the past, the S&P 500’s forward returns over the next few weeks and next 6 months were more bearish than random:

My base case is that stocks will underperform in 2021, with the first half of 2021 being more dangerous than the 2nd half.

December 14, 2020

Sector Breadth

As I mentioned last week, breadth is improving around the world. The % of S&P 500 tech stocks above their 200 dma has reached the highest level since the great 2017 rally:

When so many stocks were in a long term uptrend, the S&P 500 information technology sector usually pushed higher over the next year:

*The following table looks for the first time in 200 days

Given the current animal spirits that are lifting up markets and extremely high valuations, will this be the last blow-off top before a major market decline?

Commodities

Commodity prices are surging, with iron ore prices being one of the latest to join the advance. Commodities such as copper, sugar, soybeans, and oil have already rallied, pushing the Bloomberg Commodity Price Index to its highest level in over 5 years:

While standard technical analysis teaches us that breakouts are bullish, historically this has not always been the case for commodities. Commodities usually fell 1 year later, with 2 major exceptions at the start of the 1970s commodities bull market and the start of the 2000s commodities bull market:

Momentum

As the WSJ noted, household networth is at a record high thanks to rising stock and real estate prices.

This marks the greatest 2 quarter rate-of-change in the Fed’s calculation of household & non-profit networth.

From 1952-present this has only happened 3 other times:

  1. After the 1973-1974 bear market and recession
  2. At the top of the dot-com bubble
  3. After the 2000-2002 bear market and recession

The 1975 and 2004 historical case occurred after long term bottoms while the 2000 historical case occurred at a long term top. Either way, such powerful gains consistently led to below-average returns for stocks over the next 6 months. Even bull market rallies do not last forever.

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