Equities: choppy near All-Time Highs, US Dollar: weaker, commodities: smoking hot!

The S+P 500 index chopped up and down within a narrow range this week after surging ~9% the previous four weeks. Implied volatility was also choppy day-to-day, but it was close to one-year lows at the end of the week – a sign of complacency.

My view the past couple of weeks has been that the market is, once again, “priced for perfection” and is at risk of (at least) a mild correction sometime within the next few weeks. I’ve taken small, limited-risk positions in anticipation of a correction, but I’m wrong on that call so far. I’ll discuss my trade timing in the Trading section below.

The major stock indices have had spectacular rallies since the panic lows made in March last year. The S+P is up ~90%, the Nasdaq 100 is up ~110%, and the small-cap Russell is up ~135%. Last week I noted that the rally had been in two roughly equal parts, 1) March 2020 to November 2020, and 2) November 2020 to now.

What drove the rally?     CLICK HERE

During a recent CNBC interview, Jeremy Siegel suggested stocks could rise another 30% before the boom ends. Just when it seems like “euphoria” can’t get much more “euphoric,” every bullish guest in the financial media attempts to “out bull” the previous.

“It isn’t until the Fed leans really hard then you have to worry. I mean, we could have the market go up 30% or 40% [this year] before it goes down that 20%. We’re not in the ninth inning here. We’re more like in the third inning of the boom.”

Such isn’t the first time someone has made these types of predictions.

In 2013, I made the same statement:

“Despite all of the recent ‘bubble talk,’ it is entirely possible that stocks could rise 30% higher from here. However, it is not because valuations are cheap. As I discussed in my recent analysis of Q3 earnings, stocks are trading near 19x trailing earnings.”

Of course, the reason at that time was more “Quantitative Easing” from the Fed. Bernanke was rapidly expanding its balance sheet as automatic spending cuts from the “Debt Ceiling” comprise started.  However, the “fiscal cliff” never occurred, and massive amounts of liquidity flowed into asset markets instead.

While Siegel makes some valid points about the coming economic expansion due to massive fiscal liquidity, there are significant differences in the technical and fundamental underpinnings.

Valuations Are Astronomical

In 2013, as noted above, valuations on stocks were around 19x trailing earnings. While certainly expensive, valuations had not yet eclipsed previous “bull market” excess of 23x earnings. As shown below, even if we assume no increase in the index price, the market will remain well above 20x earnings over the next two years.

It is worth noting that historically when the market has traded at such a deviated level from valuations, forward returns have not been good.

Furthermore, earnings are currently trading well above the long-term exponential growth trend, and expectations are earnings will surge to a new peak by EOY 2022. Given this deviation from the long-term trend, it leaves a good bit of room for disappointment.

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Recently, Bank of America’s Savita Subramanian discussed why the market could drop to 3800. She discussed her thesis in her latest strategy note titled “Five Reasons To Curb Your Enthusiasm.”

This analysis is interesting, particularly when analysts are rushing to upgrade both economic and earnings estimates.

What Subramanian questions, and something we have asked previously, is all the “good news” already “priced in?”

“Amid increasingly euphoric sentiment, lofty valuations, and peak stimulus, we continue to believe the market has overly priced in the good news. We remain bullish the economy but not the S&P 500. Our technical model, 12-month Price Momentum, has recently turned bearish amid extreme returns over the past year.”

With investors “all in,” we suspect a correction is more likely than not.

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