June 30, 2021
Good morning,
The common thread running through recent Morning Notes has been that despite stretched valuations, there may be more time left for the bulls – basically so far, so good, for now.
Recall the third leg of the market analysis 3-legged stool, the first two being the Tape and the Fed. Number three is beware of the crowded extremes. Watch sentiment and valuation indicators as a warning sign of what is being priced into the market. The actual signal, bullish or bearish, doesn’t occur until the indicator reverses from its extreme.
Also remember that it is a lopsided stool – the legs are not equal. From an attribution perspective of informing portfolio changes at any given time, the Tape is 50%, the Fed 30% and Sentiment 20%. One reason for the seemingly low attention to sentiment is because sentiment indicators don’t live at extremes, they spend most of their time moving in between and rarely touching their extremes – much of the time they are signal-less. As you would imagine then, historically, it pays to watch them at extremes.
This morning we look at a few sentiment indicators that are stretched to an extreme in most cases but have not yet reversed. Margin debt is but one measure of speculation. Like most other measures of household debt, it is at record high levels today. It has not turned down to give a sell signal yet, but if it does, history shows a hypothetical loss from three to 18 months later.
Tobin’s Q (don’t ask) is a measure of market value ($45.1 trillion) versus the adjusted net worth of corporations ($26.2 trillion). At 1.7, it is well above the long-term upwardly biased linear regression trendline that suggests the norm is around 1.2. We are some 46% over the norm. Stocks have historically struggled when they are this overvalued. On the other hand, when below -32% versus the norm, stocks have shot up at a hypothetical rate of 16.5% per annum. Valuations matter in the long run.
Stock offerings got up to excessively high levels of “insider selling” and have now turned down providing a new sell signal. Not to worry, our analysis is a balance of evidence methodology and early sell signals are put into the calculus but do not move the needle all by themselves.
The point of all this today is that we seem to be living with a maturing bull market, but its end does not seem imminent. From a trust but verify perspective, sentiment seems to be confirming the mildly bullish Tape readings we noted on Monday. And it’s worth repeating … for now.
Be well,
Mike