Apophenia, Armageddon or AR-MAG-“A”-DDON?

Calls for Armageddon and market crashes grow (as fantasy patterns appear); are they justified? And what would you do if they were?

FIVE THINGS YOU SHOULD KNOW

1. Equity Markets – declined this week with U.S. stocks (S&P 500) down -2.47% while international equities (EAFE) fell -2.92%
   
   
2. Fixed Income Markets – also saw declines with investment grade bonds (AGG) down -0.43% while high yield bonds (JNK) fell -1.04%
   
   
3. Central Banks to the Rescue on Rates? – “ECB (European Central Bank) member Schnabel again addressed yields, stating rising yields may result in more central bank activity and the bottom line is global central banks are stepping up the rhetoric against rising yields. But, until the Fed joins in that messaging (which so far they haven’t) the impact of central bank commentary will be minimal on the U.S. market.” (Sevens Report)
   
   
4. Data Stays Strong – One of the reasons rates continue to rise is that growth and inflation continue to post strong numbers. This week it was the important durable goods report that blew out expectations (up 6.3% year over year) to return to pre-COVID highs, along with better jobs data as claims fell by over 100,000 week over week.
   
   
5. Key Insight – [VIDEO] Calls for Armageddon and market crashes grow as fantasy patterns appear – are they justified and what would you do if they were? [ARTICLE] This week we’ll highlight some great charts and info to show just how extreme things have gotten amongst investors, what drove the narratives this week and why things still look bright over the next 6-12 months.

INSIGHTS for INVESTORS – This Manic Market

Intro

It doesn’t take much to get investors whipped up into a frenzy; particularly when sentiment has reached such extreme levels amongst different groups and the world is still pretty raw from the mix of COVID related issues and politics.

This week we’ll highlight some great charts and info to show just how extreme things have gotten amongst investors, what drove the narratives this week and why things still look bright over the next 6-12 months.

Investor Mania

Perhaps it’s because too many people are still stuck at home with not enough to do, but people are taking extreme positions on just about everything these days (including the stock market) as they likely overthink things.

Bespoke highlighted this reality this week with some great information, and corresponding charts, that show both bearishness and bullishness are at historically high levels.

They began by pointing out that the number of investors concerned about a crash is at levels not seen since 2008/9 (see chart below), which means “(f)rom a contrarian perspective, investors should be comfortable when there's this much concern about a crash, because crashes usually don't happen when everyone is expecting one. That being said, this is only one reading, and there are certainly other sentiment measures (and real market activity) that are more suggestive of investor complacency."

Source: Bespoke

They continued by comparing this with the simultaneous levels of speculation amongst other investors noting that “(w)hile the Crash Confidence reading is telling us that a market crash is actually not likely because too many people are expecting it, the irrational exuberance reading from individual investors tells us that there is a lot of FOMO (fear of missing out) in the market at the moment. Of course, FOMO can reverse rapidly these days with a few weeks of market declines, so we'll be interested to see where this reading goes if more "frothy" areas of the market continue to decline.”

Source: Bespoke

Both our experience here at TEN, and other statistics strongly suggest that this divergence is largely explained by differing age groups. With the new millennial “Robinhood traders” that have opened over 60 million new investment accounts in the last 12 months piling into “garbage stocks” while their retiring parents brace for the worst.

For all the braggadocios attitudes among the young, and still “unscarred”, fund flows show their stomach for volatility is not much higher than their folks. In addition to the non-sense a month ago around Gamestop, AMC, etc. this week brought further evidence with incredible outflows from the once high-flying family of ETF’s at ARK that focused on tech-based and so-called disrupter stocks.

After piling into these ETFs en masse the last few months, this week’s volatility quickly shook out the weak hands as “ARK Invest ETFs suffered $443mm in outflows yesterday bringing the three-day outflow to $1.53bn or 2.7% of assets as-of 2/22. As shown at right, that’s a massive outflow for the product group given its absolutely sterling track record of attracting new investor cash. Pre- market, the flagship ARKK ETF is down 2.8%; a drop today would make it 8 of the past 9 days. This is a great space to watch for assessing the damage to aggressive equity strategies fueled by momentum.

This Week’s Narrative

This week’s “cause” for market volatility was chalked up to, which was certainly to some degree appropriate, the tremendous rise in Treasury yields. We’ve been warning about the dangers around conservative fixed income with any duration well over 6 months now, and continue to think this classic “safe-haven” asset class is far more dangerous than most realize – even before one realizes they can’t even keep up with inflation at today’s rate levels.

While the notion that bonds (e.g. Treasuries) and stocks are inversely correlated (i.e. one usually goes up when one goes down) is largely misunderstood (just look at the last 30 years where both went up), it is nonetheless true that disorderly movements in yields are an issue for the stock market.

As Tom Essaye explained, “The rise in the 10-year Treasury yield that’s occurred over the past two weeks has been compared to the “Taper Tantrum” of 2013, but there’s a key difference in this rise in yields vs. the last one: This rise in yields is happening despite the Fed promising not to reduce QE, as surging yields are being driven by rising economic growth expectations … We cited research from Goldman Sachs that stated a two standard deviation move in Treasury yields in a month has historically caused equity market volatility. A two-standard deviation in yields is about 36 basis points. With yesterday’s rally in yields, the monthly gain in the 10-year yield surged through 36 basis points, and on cue we saw equity market volatility increase.”

That said, while we think rates will continue to rise, global central bank commitment to continuing their bond purchasing programs (see summary point #2 above) will likely keep it somewhat constrained and therefore, reduce the disruption stocks experience.

In any case, as we mentioned above the correlation between stocks and bonds is likely to continue to break down as Fed intervention wanes and/or loses its effectiveness.

As commentator Avi Gilburt playfully pointed out this week, it’s “Time for another dose of reality about the market. So, all I have heard for soooo many years is that if the market is going down, you should "hide in bonds," as they are a good safe haven when the market declines. Yet, has anyone even looked at the multi-decade bond trend which has been up along with the market uptrend? So, now, what happened to bonds down, market is supposed to be going up? But, now bonds are down, and everyone is yelling that the market is going down because interest rates are rising. Which is it folks, as you cannot have it both ways!?!?!?!? In truth, most people just fit the narrative to what is going on at the time in the markets. In other words, it’s all noise. So, if you still don't believe me, let me ask you this: are markets not able to rally when rates rise? Hmmm … maybe you should look at your market history if you believe this. I have warned many times before about seeming "correlations," as when they break down, they will have you quite confused. So, if you want to know what the market is going to do, follow the market. PERIOD!!!! And, if you want to look under the hood in the market, I suggest you look at the underlying stocks which make up the market . . . and the question you need to ask yourself - are stocks set up bullishly for 2021?”

Well, are we…let’s take a look.

So What is the Outlook at this point?

For those of you in the “bracing for a crash” camp here are some reasons to be a bit more optimistic over the intermediate term.

Famed investor and hedge fund legend Ray Dalio addressed the concerns about a stock market bubble this week in an article (https://www.linkedin.com/pulse/we-stock-market-bubble-ray-dalio/?trk=eml-email_series_follow_newsletter_01-hero-1-title_link&midToken=AQH3SJ_X6EhYSw&fromEmail=fromEmail&ut=0UecXfpaklzFE1) stating, “I’ve seen a lot of bubbles in my time and I have studied even more in history, so I know what I mean by a bubble and I systemized it into a “bubble indicator” that I monitor to help give me perspective on each market. What I mean by a bubble is an unsustainably high price, and how I measure it is with the following six measures.”

1. How high are prices relative to traditional measures?
2. Are prices discounting unsustainable conditions?
3. How many new buyers (i.e., those who weren’t previously in the market) have entered the market?
4. How broadly bullish is sentiment?
5. Are purchases being financed by high leverage?
6. Have buyers made exceptionally extended forward purchases (e.g., built inventory, contracted forward purchases, etc.) to speculate or protect themselves against future price gains?

He concluded, that in general the market does not appear to be in a bubble, but he did recognize that “There is a very big divergence in the readings across stocks. Some stocks are, by these measures, in extreme bubbles (particularly emerging technology companies), while some stocks are not in bubbles.” Invest accordingly.

Beyond Dalio’s analysis, and his opinion should rarely if ever be ignored, earnings and macro data continues to come in quite strong. JPMorgan analysts pointed out that earnings estimates continue to increase and that in this most recent earnings season “81% of companies have beaten earnings estimates, and 68% of companies have beaten revenue estimates” while also forecasting general growth for the remainder of 2021.

On the economic data front, it was a week of tremendously positive data with personal income +15% year-over-year (yoy); durable goods tripling expectations to rise to pre-covid levels and US GDP being revised up from +4.0% to 4.1% in Q4.

In Closing

As Brian Wesbury likes to say “volatility is the price investors pay to make money in the market” or as I like to say “volatility is the path to making money without pushing a broom” (smiles). Either way, don’t let the inevitability of volatility scare you off course for the equal inevitability of the resilience of markets over time.

Have a wonderful weekend,

Tim and the team at TEN Capital