Traders see the all-clear for a reopening rally. Are you proper this time?
Traders work on the trading floor of the New York Stock Exchange.
Shrewd market watchers are quick to mock and taunt when small investors fuel a stock rally.
And cheer for responding to a clear election result last week and encouraging news on Pfizer's Covid-19 vaccine trials with an emotional buying spurt at the opening on Monday, the biggest inflow for equity funds in years and one of the biggest leaps in retail's Optimism the investor is palpable.
Given that the crowd is known to be extremely wrong, skeptics swiftly seized on evidence last week that the public was taking the "all clear" as a warning that fuel was running out for further market gains.
There is no doubt that investors who had crouched defensively before the "known unknowns" of the presidential election and vaccine development before finally reaching for stocks in a moment of clarity last week bought much higher than they could have .
When the S&P 500 opened about 3% higher on Monday, it was 11% above what it had closed just ten days earlier when there was talk of "uncertainty" and downside risk. Just two weeks after we realized that investors were afraid of attempting a rebound towards the end of the year. It's understandable that people want to be part of a fourth quarter rally, but the S&P is already up 6.6% this quarter, more than the average profit for the October-December period.
Just because they paid to wait doesn't mean they bought a market top.
The history of such sudden public relief shows that they are usually not the greatest entry points, but are also a far cry from automatic rally killers.
In the past week, nearly $ 45 billion in net inflows flowed into equity funds, what Bank of America calls an all-time record.
As the graph here shows, the last comparable revenue was in January 2018, a month when an angry rally peaked in the afterglow of a long-awaited bullish catalyst, the passage of the Trump tax cut weeks earlier. The market soon got into a harrowing correction, then a troubled sideways phase, before returning to these highs within months.
Bank of America's global strategist Michael Hartnett sees these flows and the synchronous rise in global equity markets to overbought extremes as an indication of a high point in this progress.
"We're a strong seller of vaccines," he says, based on "top position, top policy, top earnings in the coming months," comparing them to the 2018 pattern.
Is it a top of the market?
Members of the American Association of Individual Investors have been among the tougher groups distrusting the market since the low in March, and have had sub-par positive sentiment for a record stretch in the group's weekly newspaper – until last week.
The bulls in the poll, which runs every week through Tuesday, rose from 38% to 55% – also the highest since January 2018. The history of similar jumps in AAII bulls since the poll began in 1987 is a little below average – but always still positive – S & P 500 will return in the coming months.
SentimenTrader, a research service that analyzes the impact of investor attitudes and behavior on the market, examined previous data when the bullish AAII percentage rose more than seven percentage points and poured more than $ 7 billion into equity funds.
The combination of factors hit the bull market best in 2003-2007, but other than that, these weren't a particularly bad time to buy stocks, with forward prices ranging from six months to a year to be respectable.
In other words, when investors get excited it can mean the market is cooling down a bit and may be less able to shake off scary headlines. However, it's not worth immediately assuming that a bullish audience will automatically be proven wrong. Not every rally is hated, not every upward trend happens in the ironic rejection of the consensus, not every trade is the "pain trade".
Another overshoot like in June?
Granted, the strength of the market over the past week seemed inappropriate in other ways. Gains were clearly led by cyclical stocks that were closely aligned with a reopened economy, though the daily news flow was marked by an alarming spike in Covid cases and newly imposed business restrictions and socially distancing orders.
A buyer of the inaugural pop on Monday with the S&P 500 over 3600 for the first time is still underwater, despite the S&P gaining more than 2% on the week as the buying frenzy subsided and the huge growth stocks that dominated the index, faltered.
Monday was the worst day ever for momentum investing, and overall money flowed from growth to value, from big stocks to small home games, from back-to-work names, from annual winners Laggards and defensive to cyclical.
If the message of the market can be understood at face value, it is encouraging to the economic outlook and supports the stock rally. But the day-to-day action has been unpredictable enough – in times like automated pinball machines with an investment factor – that it's hard to tell.
Can these shifts be seen as the market looking resolutely beyond the imminent slowdown of a winter virus outbreak to a moment in early 2021 when treatments and vaccines will free the economy? Or was this another overshooting of the reopening craze, as we saw in early June before a market setback and a return to the shelter of the mega-cap growth treasure trove?
This is the debate that was scheduled last week for investors over the coming weeks.
Aside from getting sentiment and stock flows a little dizzy, the fundamentals of the market are hard to fault. The rally has been broad in recent weeks and has shown urgency from buyers, although that predicts strength beyond the next month.
Earnings projections for early 2021 are rising and the multi-month downward movement of the S&P has allowed earnings to catch up, making the market look not cheap but a little less valuable than it did in midsummer.
It's difficult for stocks to have too long-lasting problems when credit markets are strong enough that junk bond yields fell below 5% for the first time. Maybe frothy, but free from financial stress.
And, of course, the seasonal patterns are favorable – which won't necessarily change just because most investors are now in a full sprint to get a year-end rally.