You've got to ask yourself one question You've got to ask yourself one question\images\insights\article\bubble-wand-small.jpg August 21 2020 August 21 2020

You've got to ask yourself one question

Is it a bubble?
Published August 21 2020

[The subject matter of my calls this week took a stark turn. Now everyone is focused on the election. “What should I do if my guy doesn’t win,” I was asked. My response—I don’t need to know who your guy is, because for the market, it doesn’t matter who wins. In a few weeks, the Mister and I will go on vacation, and I will offer you my Election Special to explain.]

“‘Do I feel lucky?’ Well, do ya, punk?” This is Clint Eastwood’s infamous question to an injured criminal in the 1971 movie, "Dirty Harry." This week the S&P 500 closed at a new record high, taking just 103 trading days to erase its 35% decline, the fastest-ever recovery to a new high after a drawdown of at least 30%. Breadth, however, remains underwhelming. Decliners are outnumbering advancers by about 2.5 to 1, with the median stock roughly 28% away from all-time highs. A mere 6% of S&P constituents are at 52-week highs, vs. 25% at February’s peak. Not the best. Also, the 12-month forward earnings yield (per-share earnings divided by market price) is at its lowest on record, even with significant increases in estimates among beaten-up cyclicals. Gulp. Since late May’s bottom, sector earnings for Energy, Consumer Discretionary, Materials, Industrials and Financials have been revised up a respective 239%, 26%, 11%, 10% and 9.5%. Still, the valuation gap between yields on forward earnings and bonds has narrowed, suggesting investors may have bid stock prices far above what’s justified. At $4.6 trillion, money market cash represents 14% of the stock market, a zone where Ned Davis says gains historically have been below average. The only other times when the Dow’s price-to-book value topped 4, as it did this month, were in 1929, 2000 and 2007. Hmm.

To be sure, rate suppression is a boon for cyclicals. Renaissance Macro sees the current environment as being almost exactly opposite that of late summer 2018. Back then, the news was almost unambiguously good with the exception of China trade tensions. Manufacturing was running hot, producer prices were subdued, the 10-year Treasury yield was approaching 3% and the Fed was in the midst of a rate-rising cycle, hiking the target rate a quarter point that September and indicating another increase was likely by year-end 2018. Almost immediately, cyclicals vs. defensive names signaled the Fed was overstepping, resulting in one of the worst fourth quarters for equities ever. Today, this cyclical vs. defensives trade indicates rates are low enough to spark a recovery, despite a challenging news cycle, Covid or no Covid, Democrat or Republican in November. Yardeni sees the Fed embracing the analysis of influential French economist and MIT Professor Olivier Blanchard, a senior fellow at the Peterson Institute for International Economics. His conclusion: Don’t tighten until you see “the whites of inflation’s eyes.” Chair Powell on June 10 essentially stated he doesn’t care if the Fed is creating an equity market bubble. It doesn’t get more bullish than this for stock investors. The danger to the market is unlikely to be economic data, Ren Macro says, but rather the sensitivity assets will have to monetary policy when it eventually begins to tighten at some point well down the road. In an email to its future self, it says, “Remember to sell assets when the Fed tightens, no matter how good things are or how smart you think you are.’’

Q3 GDP is expected to jump at annual rate of at least 20% on the initial surge in activity, with goods demand likely back at pre-pandemic levels. Applied Global Macro Research sees a quick earnings recovery and says that while service activity may continue to lag, it’s less important for profits than it is for GDP. (Fundstrat shares that social-distance spending at bars and restaurants and for take-out represents $717 billion, just 4% of the $17 trillion consumer wallet.)! Applied Global thinks profit growth over the next 12 months will be the strongest in decades and is forecasting a 60-80% increase in nonfinancial corporate profits from Q2’s low through Q2 2021 and nonfinancial corporate profits to reach a record high in next year’s first half. Yes! And because recessions tend to lead to rising profit margins and sustained multiyear profit cycles, it expects profits and earnings to be higher in 2022 than they would have been even in the absence of the Covid recession. Woo-hoo! Outside of housing, the economic data appears to be softening, signifying a shift from a “V” to what Cornerstone calls a “wavy” recovery pattern—moderating improvement, with ups and downs on Covid flare-ups and pauses in reopenings. The overall economic trend remains solidly up, however. So, therefore, you’ve got to ask yourself one question. “Is this a bubble? Well, is it, fellow investment professional?”


  • Don’t count out a ‘V’ July existing home sales shot up to a 14-year high, while housing starts jumped the most in almost four years and housing permits soared the most since January 1990. August home builder confidence also beat expectations, matching its highest level on record.
  • Don’t count out a ‘V’ Markit’s initial read on August business activity jumped to early 2019 levels as both the manufacturing and services sectors saw a resurgence in new orders. Its flash composite PMI rose to 54.7, its highest since February 2019, with the manufacturing component its highest since January 2019 and services its highest since March 2019. Regional manufacturing data was less robust, as gauges in the New York and Philly partially retraced recent gains but remained expansionary.
  • Don’t count out a ‘V’ Conference Board leading indicators rose a third straight month in July by a robust and better-than-expected 1.4%, with six of 10 components contributing.


  • Jobs recovery slows New jobless claims no longer are collapsing—they rose above a million again in the latest week. Although continuing claims fell, they too remain at extreme highs on a historical basis.
  • Consumers want their stimulus Retail sales have flattened the past nine weeks, and Bloomberg’s monthly survey shows consumers remain deeply negative as pessimists outnumbered optimists a sixth month in a row. Bloomberg’s weekly consumer comfort gauge also slipped and, while off May’s recession low, is 23.8 points below January’s pre-recession high.
  • Benefits cliff Fiscal stimulus is starting to fade with the economy less than halfway back to full health. Congress and the White House remain at loggerheads, and Trump’s executive orders aren’t expected to have much impact and won’t kick in until September. The lack of action comes as mortgage delinquencies spiked in Q2 to a 9-year high and credit card delinquencies hit a 7-year high.

What else

Cash still king Covid revealed people will hoard paper money despite the availability of other payment media and still use coins and low-denomination bills to make low-value purchases. Indeed, a shortage of coins emerged in June, when the Fed's inventories plunged as shutdowns froze coins in cash registers of closed businesses. Meanwhile, demand for $20s and $50s soared more than 30% annually.

It doesn’t matter who wins Trend Macro notes that, amid a broad discussion of all the risk factors holding back business spending, the word "election" wasn’t mentioned even once in July Fed meeting minutes.

Life is like a box of chocolates In the 1994 movie, Forrest Gump bought a stake in Apple worth $100,000. Bank of America says that today, that share would be worth $60 billion.

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Tags Active Management . Equity . Markets/Economy . Coronavirus .

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Dow Jones Industrial Average ("DJIA"): An unmanaged index which represents share prices of selected blue chip industrial corporations as well as public utility and transportation companies. The DJIA indicates daily changes in the average price of stocks in any of its categories. It also reports total sales for each group of industries. Because it represents the top corporations of America, the DJIA's index movements are leading economic indicators for the stock market as a whole. Indexes are unmanaged and investments cannot be made in an index.

Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.

Price-To-Book Ratio is used to compare a stock's market value to its book value. It is calculated by dividing the current closing price of the stock by the latest quarter's book value per share. Also known as the "price-equity ratio".

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

Stocks are subject to risks and fluctuate in value.

The Bloomberg Consumer Comfort Index is based on weekly telephone survey of consumers seeking their views on the economy, personal finances and buying climate.

The Conference Board's Composite Index of Leading Economic Indicators is used to predict the direction of the economy's movements in the months to come.

The Markit Composite PMI is a gauge of manufacturing and service activity in a country.

The National Association of Home Builders/Wells Fargo Housing Market Index is a gauge of how well or poorly builders believe their business will do in coming months.

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