Market overview: tech and growth stocks surge
Here's my market outlook:
Long term risk:reward (e.g. 1-5 year basis) doesn’t favor bulls. Valuations are high, but valuations can remain high for years before stocks crash.
Fundamentals (6-12 months): still bullish because there is no significant U.S. macro deterioration.
Technicals (1-3 months): mixed/bearish
Fundamentals (6-12 months)
The economy and the stock market move in the same direction in the long term. Hence, leading economic indicators are also long term leading indicators for the stock market.
Overall, there is no significant U.S. economic deterioration right now. This is bullish for the stock market on a 6-12 month time frame. With that being said...
Financial Conditions
As Jason noted on Friday, financial conditions are extremely easy right now. This is a bearish factor for equities over the next few months.
Manufacturing
Manufacturing-related economic data continues to be relatively weak. Industrial Production's year-over-year % change is now negative for 5 months in a row:
The last 3 times this happened were not kind to stocks. Stocks tanked after June 2001, August 2008, and August 2015 (S&P fell again in early-2016). But before that, this often happened at the end of a recession or economic slowdown. Overall, I'm not too concerned about weakness in manufacturing.
Consumer sentiment
And finally, the University of Michigan Consumer Sentiment Index has rallied to the highest level since early-2018:
When Consumer Sentiment rallied to an 18 month high and was above 100, the S&P's forward returns weren't consistently bearish. Granted, most of the bullish cases occurred as a cluster (1997), which makes this stat seem more bullish than it really is.
Technicals (6-12 months)
Bullish:
Momentum
The U.S. stock market's momentum remains extremely strong. While this is a modest bullish factor for stocks over the next 1-3 months, it's even more positive for stocks 6-12 months later.
As Jason mentioned on Thursday, the S&P started this year with a bang. When this happened in the past, the S&P always pushed higher over the next 6 months.
As Jason noted on Wednesday, a consistently large % of S&P 500 stocks have been in a medium term and long term uptrend. When this happened in the past, the S&P (once again) was always higher 6 months later.
As I mentioned on Friday, the S&P has gone a long time without a -5% pullback and is far above its 200 dma in terms of standard deviations. When this happened in the past, the S&P always rallied over the next year, with a median gain of +18%.
Technicals (1-3 months)
Our outlook over the next 1-3 months is mixed/bearish. Let's start with the bearish factors, and then we'll examine the bullish factors.
Bearish:
Sentiment
Sentiment was extremely optimistic until the stock market's brief pullback in late-January. Since then, the stock market has surged higher but sentiment hasn't reached prior highs. As Jason mentioned on Tuesday, less interest in chasing higher prices does not bode well for stocks 3 months later.
In the meantime, traders continue to buy *too many* calls in relation to puts. The Put/Call ratio remains extremely low, which in the past was consistently bearish for stocks over the next few weeks.
The sector that's most responsible for the stock market's relentless rally is tech. XLK (tech sector ETF) Optix's 50 dma has risen to one of the highest levels ever. When tech sentiment was this optimistic in the past, XLK's returns over the next month were poor:
Speculation
Depending on how you look at it, there is some speculative fervor in the markets. Stocks are rallying nonstop while speculative assets like Bitcoin are surging. The S&P is up more than 5% over the past 2 months while Bitcoin has surged 42%.
Let's run a historical stat using the S&P and Bitcoin to determine "speculative fervor". Now granted, running this stat on Bitcoin's early price history (e.g. pre-2013) doesn't make a lot of sense, since Bitcoin's fluctuations were much larger back then than it is now.
Here's what happened next to the S&P after the S&P rallied >5% over the past 2 months while Bitcoin surges >42%:
Excluding the early years in which Bitcoin was much more volatile, this is a minor bearish factor for U.S. equities over the next 2 months.
High beta vs. low volatility
As several media outlets and traders have noted, Low Volatility stocks are outperforming High Beta stocks. The S&P 500 Low Volatility Index has surged over the past month while the S&P 500 High Beta index languished.
While it's easy to assume this means that "investors are avoiding risk as they prefer to hide out in low volatility stocks", this wasn't usually a bullish factor for stocks in the past. Since this frequently happened during the 2000-2002 bear market, the S&P's returns over the next 3-6 months were usually bearish.
Growth vs. Value
And finally, Bloomberg noted that growth stocks have surged in comparison to value stocks. This isn't surprising given how much tech stocks have rallied.
Looking at the 3 month % change in the S&P 500 Growth/Value ratio, it's clear that the recent surge in growth vs. value is extreme:
When investors/traders preferred growth over value this much in the past, the U.S. stock market's returns over the next month were consistently weak.
Here's what the S&P 500 Value Index did next:
Here's what the S&P 500 Growth Index did next:
Bullish:
Breadth + momentum
As I noted on Thursday, the % of NYSE issues making new highs has risen to the highest level in more than 2 years. A surge in New Highs is usually bullish for stocks over the next 2 months.
To recap:
Long term risk:reward doesn’t favor bulls.
Fundamentals (6-12 months): still bullish because there is no significant U.S. macro deterioration.
Technicals (1-3 months): mixed/bearish