The level of speculation from retail traders has reached unreal levels. On Twitter we polled our followers asking if they know someone who just started trading this year and has done very well. 52.6% of the 76 respondents said they do know someone like that. Anecdotally, this expansive level of speculation seems to have trickled down to almost everyone who would ever think about opening a brokerage account. There’s nothing wrong with starting out with a free trading platform. The problem is these new investors have tunnel vision. They want to make money. They don’t have the perspective that if almost everyone is opening accounts and buying the same stocks, eventually it won’t work.
This is what makes investing so tough. You need to be good at analyzing the fundamentals and understand what other investors are thinking. You don’t want to make a decision based on something that’s priced in. Imagine you owned a stock that was down 35% because of fears of a dividend cut. You sold the stock on the news of the cut only to see it subsequently rally. It’s extremely difficult to figure out what is priced in.
Goldman Compares This To 1999
However, in this case it’s quite easy to see the herd is very optimistic. Herding into and out of stocks creates opportunity. It is a clear and obvious risk to the current bull run. Goldman Sachs stated, “By every metric we track retail activity is the largest since 99/00. I have been tracking cross asset flow-of-funds for past 16-years. I could never imagine typing the following. Yesterday we saw retail, message board traders, stop-out shorts from institutional investors.” That last point is referring to stocks like Hertz which rallied after it declared bankruptcy. For context, Carl Icahn sold his massive stake before the rally. That shows how difficult timing a market in euphoria can be. 160,280 Robinhood users had shares in Hertz on June 10th.
Total user positions at Robinhood was 16.41m on Feb 19, the SPX high.
It surged to 21.48m on Mar 23, the day of the low. This was a 31% increase as stocks declined 34% in six weeks.
From the low through yesterday, total user positions have soared to 37.13m, up 73%.
— Jim Bianco (@biancoresearch) June 9, 2020
As you can see in the chart above, the number of new Robinhood accounts exploded during the bear market. Then the number of new accounts spiked even further during the subsequent rally. They bought the dip and then FOMO investors got involved. Accounts with positions went from 16.41 million in February 19th to 21.48 million in March 23rd. Then new users spiked 72% to 37.13 million. On the Google Play Store, Robinhood was the 4th most popular finance app. In a sign of the times, the EBT food stamps app was number 5. The economy is struggling while stocks recover.
NOT A NORMAL EARLY CYCLE MARKET
The working theory is that stocks are at the start of a multi-year bull market because the economy is recovering from its short deep recession. Many commentators are saying the economy isn’t the same as the stock market. It’s possible this theory rings true in reverse as the economy recovers while stocks do poorly. In theory, it makes sense for stocks to rally after recessions, but context matters.
Valuations are important. You can only say that stocks are at the start of a multi-year bull run if you ignore prices. Normally stocks are cheap at the start of cycles, but not this time. We can’t just ignore the best 53 day run since 1933 which has made stocks expensive. As you can see from the chart below, the S&P 500 5 year normalized PE ratio is 25.5 which is in the 95th percentile. It’s above the average of 19.2 since 1957. Stocks do well at the start of cycles because they are cheap. You can see how cheap the market got at the bottom of the prior recession. This isn’t like that. We are already seeing high speculation among retail investors.
If this is a new bull market, it has achieved—in two-months’ time—what took the last bull market more than eight years to accomplish: surpass 25x on our Normalized P/E ratio. pic.twitter.com/YnjoOZISaB
— The Leuthold Group (@LeutholdGroup) June 9, 2020
Which Data Is Right?
It appears the consumer is improving based on Visa and Mastercard usage in May. We’ve also seen that retail traffic growth at brick and mortar stores improved 6.5 points in the first week of June to -69.7%. Wendy’s same store sales growth bottomed at worse than a 25% decline in April. Same store sales growth improved to -1.9% in the end of May. The data didn’t improve throughout May because there was a beef shortage. In keeping with that data, the chart below shows Morgan Stanley’s retail tracker anticipates double digit monthly retail sales growth in May. It has been correlated with core sales growth in the past. The retail sales report comes out on Tuesday June 16th.
The @MorganStanley Retail sales tracker points to +10% rebound in sales in May
— Gregory Daco (@GregDaco) June 10, 2020
Not all the numbers are rosy as the Redbook yearly same store sales growth reading fell from -7.2% to -9.7% which is about the trough of this cycle and the entire 2 decade history of this report. That’s from the week of June 6th. Those other readings we mentioned (besides brick and mortar traffic) were from May, so it’s possible both are correct. It would be bad if sales growth fell back in June.
Phase 2 Is Coming Soon
The chart below makes the point we did in our May BLS article. In the beginning of this cycle the low hanging fruit jobs will be coming back. The temporary job loss that quickly turns back into employment is the low hanging fruit. You can’t expect the job creation in May and the expected strong creation in June to continue. Next is phase 2 in which some temporary job losers don’t get their jobs back and hiring picks up gradually. Phase 1 growth is all about reopening. It’s a quick jolt that isn’t sustainable.
We're expecting a two phase labor market recovery
— Gregory Daco (@GregDaco) June 10, 2020
Most indicators show retail sales growth is coming back. Currently, the economy and stock market are detached because stocks are doing well, while the economy is still in shambles despite its increase off the bottom. The unemployment rate has far to fall, while the stock market is near its February peak. Because of the sheer speculation amongst retail traders we could see a reversal of this situation as the economy looks better and stocks are weak. Stocks are too expensive especially if your account for the potential corporate tax increase.