Who are you going to believe? The data or the lying highs?
This summer markets have again ignored all negative news. Be it trade issues, be it indictments and drama on the political front, you name it. Turkey, Venezuela, Argentina, Italy, Brexit troubles, emerging markets, China, who cares? 5 months of straight gains with little volatility not only retesting January highs, but making new index highs in the process.
And if you believe headline AUM driven punditry you are left with the impression that nothing, absolutely nothing, is going to derail a guaranteed ascent of prices. The bullish argument is rooted in US earnings growth which is fantastic given the backdrop of tax cuts. In context new highs are actually not surprising and were expected. A dovish Fed (still running negative real rates & staying accommodative with a cautious slow rate hike path advertised), trade wars are over (they’re not) 24% earnings growth, buybacks galore, nothing matters. Pullbacks are a thing of the past, get long and buy the highs. We can only go up. Perhaps a bit facetious on my part, but that is the general sentiment propagated. “Buy every dip”, “don’t wait for a dip” and above all: “Don’t sell“.
Given all this it’s of little surprise that investor sentiment is back to euphoric levels:
So why the “Lying Highs” label?
Consider the machinations of these markets. 10 years of virtual non stop global central bank intervention repressing rates, causing the TINA (there is no alternative) effect, forcing yield seeking forces to enter risk assets they otherwise wouldn’t (think pension funds). In a world where volatility compression changed the dynamics of price discovery active fund managers increasingly found their human intellect driven choices inferior to a world driven by algos, ETFs, central banks. Dissatisfied investors tired of lagging returns threw in the towel and threw their assets into ETFs. There are now more ETFs than individual stocks. Everything is indexed and automatic allocations keep buying the ever shrinking float that is out there. Shrinking because there are now significantly fewer individual stocks to buy than 20 years ago. Shrinking because record buybacks keep reducing the publicly available shares outstanding to buy.
In a year with over $1.2 trillion in buyback announcements and August seeing the largest amount of buybacks in any given year is it any wonder buybacks are helping to bid a market in an extremely low volume environment? I submit it’s not:
Passive investing funds flow into ever fewer issues and with a lack of alternatives and cash being toxic due to a continued low yield environment people treat their ETF holdings as savings accounts. After all bear markets are a thing of the past and so are corrections, just buy dips. And it has worked. Over and over again.
And it continues to work and hedge funds again find themselves having to chase index performance. Again.
The end result being that we have now entered an age of unprecedented asset price inflation in favor of the few and this trend is producing some rather obscene dislocations.
Consider: Most people will never be millionaires. Ever. No matter how hard they work, or what they do. Talent, circumstances, connections, luck, etc. The right combination and one become a millionaire. It’s even much harder to become a billionaire. On a planet of over 7.5 billion people there are roughly 3,200 billionaires. Some are born into it, some make it happen out of sheer determination and skill, but also because they are at the right place at the right time.
I believe it was Bill Gates who once mused himself that, if he had been born a few years earlier, there wouldn’t have been a computer at the school lab and he would have ended up being an accountant or something like that.
The reason I mention all this: We all are losing track and perspective of the outsized numbers that are thrown about by these markets. I mentioned how almost impossible it is to become a billionaire. Yet one individual added another $5B to his personal wealth this week. In fact it was $5B in just one day. That’s impossible to do in a lifetime for 99.99999% of individuals on this planet no matter what they do. And yet all it took is one stock upgrade.
I’m of course talking about Jeff Bezos:
$AMZN traded to over $2,000 this week, up over 70% from the 1175 level it entered 2018 with. The stock is now trading at a $981B market cap and JPM is pushing a $1.2 trillion valuation. Could well happen, I can’t say. Nothing has ever stopped this stock. It’s got a 3% profit margin and a 3.5% operating margin with a speculative small cap worthy trailing P/E of 158 and a forward P/E of 78 with a market cap near $1 trillion.
Why now the rapid acceleration in these few mega market cap stocks? Because things changed in the past 2.5 years. Record central bank intervention between 2016 and 2017, then tax cuts in 2018 all amidst the trend shift to passive investing all gathered for the perfect storm of money inflows nurtured by a positive business environment. A few stocks dominate in quasi monopoly status, benefitting from low taxes and strong expansion in their respective spaces.
The mechanics of above described market conditions then consequently produce charts like this:
$AMZN, and I’m only using this stock as a prominent example as I could do the same analysis with $MSFT and others, even during its long standing bull career has always managed to eventually reconnect with its quarterly 5 EMA. You can see it on the chart above. Just a basic reconnect with its quarterly 5 EMA implies a 23% correction from here, this is how far price has extended.
And the market cap appreciations we have just witnessed are historic stunners. Consider:
These companies are expanding in market cap size in mere weeks by amounts that dwarf 99% of listed issues on the global stock exchanges.
Status: Bulletproof. That is the action in prices, it is the attitude of investors and Wall Street. Perpetual asset appreciation. Buy 85 daily RSIs now because trillion dollar stocks are risk free.
Case in point $AAPL:
The net result: Stock valuations have again outgrown the size and growth of the underlying economy:
Let me suggest: It will never get better than this. And perhaps not more dangerous than this.
After all consumer confidence just hit its highest reading since October 2000.
Here’s the historic perspective:
It’s almost as if consumers are at their most confident before things turn sour.
It’s been said that price drives sentiment. And if the stock market is an indicator of sentiment then it’s fair to say that we have an extremely optimistic read here.
Yet we know real wages are not keeping up with inflation:
We also know debt levels keep expanding and we know that people feel safe in their ETFs. It’s a toxic combo that I submit will prove to be the achilles heel of the entire construct.
And the construct may be in trouble sooner than one can imagine as there are a number of other issues underlying the construct of this rally and I’ll walk you through some of these.
Let’s start with the bullet proof Nasdaq. New high after new highs, but on a negative monthly divergence:
And look closely. Leadership went from thin to virtually nonexistent. Leadership went from $FAANG to $AA:
$MSFT is still hanging in there in the growth columns, but slowly we are starting some of the previous leaders lag behind. $GOOGL, $FB, $NFLX are below their July highs.
On the larger $NDX we can observe ever weaker relative performance. New highs vs new lows keep getting weaker, the latest highs again showing a surprising drop:
This is also true for the larger market. While $SPX made new highs there is no expansion in new highs/new lows:
Components above their 200MA also fail to impress:
It’s the kind of weakening of underlying leadership that has spelled coming market trouble in the past.
With that burst to new highs on $NDX and $SPX we should have expected higher readings. But it didn’t happen.
Why? Because many underlying sectors have not made or failed to make new highs.
The list is long:
Indeed it smells of a failed break above the trend line:
Transports tried twice several times to make new highs, but have failed so far:
$XLI? No new highs:
Utilities? No new highs:
Financials? No new highs:
Semis? No new highs:
The $DJIA? No new highs:
So let me label market highs as unconfirmed and perhaps disproportionally influenced by 3 stocks: $AAPL $AMZN $MSFT all of which are historically vastly overextended:
That’s nearly $3 trillion in market cap in 3 stocks.
Wall Street and investor sentiment largely expects these price expansions to continue into year end:
– @reuters poll:
* GLOBAL INVESTORS RAISE OVERALL EQUITY HOLDINGS TO 48.3 PERCENT, HIGHEST SINCE APRIL
* 63% SAY IT IS TIME TO BUY EMERGING-MARKET ASSETS
* 68% DON'T SEE A CORRECTION IN LEADING GLOBAL TECH STOCKS BY YEAR-END
— Carl Quintanilla (@carlquintanilla) August 31, 2018
All that may be true, but let me also offer an alternative perspective here.
As I’ve outlined repeatedly since January we still have technical risk into 3042:
Yet all new highs are coming on negative divergences.
But not only this, but new highs are coming within a stone throws distance from long time trend lines converging on key charts.
Here’s the $OEX, the S&P100:
And here’s the $SPX:
Note the confluence of these trend lines at the January highs.
In this context let me also highlight that volatility has printed a positive divergence on these new index highs, right in context of its descending wedge.
Here’s the $VXO:
The picture that emerges: Relative strength in volatility as markets make new highs on negative divergences with weakening internal participation.
It’s a toxic cocktail mix that has revealed prior bull market highs to be lies and opportunities to sell.
A key test may come for markets in the September/October time frame. If prices can sustain above January highs the 3042 technical zone may well be reached in 2018.
If not the risk dynamic may shift dramatically especially if volatility is breaking out of its wedge pattern:
To summarize: New highs in select sectors are heavily dependent on a few high mega cap tech stocks which are all historically extended. Many sectors are either not confirming new highs or are not making new highs, volatility is showing relative strength and new highs/new lows are not confirming new index highs as volatility is displaying relative strength with fewer stocks above their 200MAs now compared to January.
Sentiment is extremely bullish and investors appear to see little risk in markets while the above factors are unfolding.
Don’t be surprised if this sentiment is tested in the weeks ahead.