/ March 11 / Weekly Preview
-
Monday:
N/A
Tuesday:
Inflation Rate YoY (3.2% exp.)
Core Inflation Rate YoY (3.8% exp.)
Wednesday:
N/A
Thursday:
Initial Jobless Claims (210K exp.)
PPI MoM (0.3% exp.)
Retail Sales MoM (0.2% exp.)
Friday:
Michigan Consumer Sentiment (78 exp.)
-
Monday:
N/A
Tuesday:
Oracle ORCL
Asana ASAN
Vail Resorts MTN
Archer-Daniels-Midland ADM
Kohl's KSS
Wednesday:
Dollar Tree DLTR
Williams-Sonoma WSM
Lennar LEN
UiPath PATH
Thursday:
Dick's Sporting Goods DKS
Dollar General DG
Weibo WB
Adobe ADBE
Ulta Beauty ULTA
Friday:
N/A
“Markets can remain irrational longer than you can remain solvent”
The title for today’s article references a famous quote by the economist John Maynard Keynes. The point he was trying to make is that timing a market “top” is inherently difficult, as bullish price action can continue for much longer than logic would predict.
Take today’s environment: even the most optimistic sell-side price targets for the S&P 500 (5.450) don’t justify stock ownership. The potential upside for the market is currently 6.38%, while the risk-free rate of a 1 year treasury bond sits at 4.92%. Normally, investors should aim for returns of about 4% above the risk free rate (8.92%) in order to be adequately compensated for the extra risk of holding stocks.
But that’s the thing about bubbles and tops - they are irrational and fueled by by their own momentum. So are we in a bubble right now? Or is the market simply overbought and due for a pullback?
Technically, SPY remains well entrenched in a bullish trend, with the market currently up 17 of the past 19 weeks. This is the longest such stretch since 1980. The compound annual growth rate of the trend since late October is around 50% and, if maintained, would take SPY to $700 by year-end. This is obviously unsustainable. Moreover, during the current 4 month rally phase, SPY’s 20-Day Moving Average has acted as key support and has only been violated for 2 days - an absolute rarity. The break of the 20-DMA will be the first technical sign of a reversion, with further support at $498 (R2, -2.68%). The rally could continue up to $532 in the short term (High Trend-Line, 3.96%).
Surprisingly, the MACD is on a SELL signal, denoting a slowdown in momentum. Coupled with lackluster market breadth, and compressed volatility, we get a “perfect storm” of soft indicators which have historically served as a warning.
Followers of our live portfolio know that we have become increasingly cautious in the last couple of weeks and chose to take profits opportunistically. Such is a course of action we plan on maintaining, as our opinion is that the next major phase will take the market lower, not higher from here. A potential 5%-10% correction would work off overbought conditions and allow for a much better entry point to deploy capital into.
We are probably not in a bubble… yet! At least not in the sense that “everything” is overvalued. Around 160 stocks in the S&P 500 (32%) have a P/E Ratio multiple below the cycle median of 20.6. Smaller cap companies have even more attractive valuations.
In 1999 it was believed “the internet would change the world” and the whole infrastructure underlying this revolutionary technology would be supplied by Cisco Systems. At that time, Cisco was selling routers with 50% gross margins and analysts extrapolated this into the future.
Today, we’ve got A.I. as the “world changing technology” and Nvidia as the provider of its infrastructure. Nvidia (NVDA) has 75% gross margins and 75% market share. Like in 1999, analysts are projecting this margin to remain elevated into the future. However, the way things play out in reality is quite different. Competition eventually erodes the “first mover” advantage and investors are stuck with the bill. As the graph from TheMarketEar below shows, investors lost 85% of their money on CSCO peak-to-through. It took 16 years to get back to even, despite the company growing revenues by 172% and EPS by 681% in the interim. Needless to say, the internet did change the world.
But overpaying for value almost never works out in the longer run.
On the plus side, there are several key differences in today’s market, when compared to the “Dot.com” bubble. In 1999, many of the companies that were trading at astronomical heights had no earnings, little revenue, and, in many cases, were running up on “made up” metrics like “eyeballs” and “clicks” per page.
Today, that story is quite different, with companies like Microsoft, Google, Amazon, Nvidia, AMD, and the rest generating billions in revenue, strong earnings growth, and fundamentally sound balance sheets. Speculative mania is happening in the crypto space, where Pepe Coin is up 91% year-to-date, putting NVDA’s 81% rally to shame. Pepe Coin is a meme token specifically created for for entertainment purposes only and carrying no intrinsic value. No matter what you think of NVDA’s valuation, the intrinsic value of its technology is undeniable.
In conclusion, we are probably approaching a market top, as only certain parts of the market are frothy. Given that sentiment is not yet euphoric, we could expect some more positive price action in the coming weeks. But once our sentiment indicator crosses into “Extreme Greed” territory, it will probably be adequate to reduce exposure more aggressively.
The key economic data point this week will be inflation - to be released on Tuesday. Economists are expecting 3.2% headline inflation year-on-year and 3.8% core inflation. Any upside surprise to these numbers would put a Fed interest rate cut even farther into the future. For now, the first rate cut is projected to arrive in June, with a total of 4 cuts priced in for 2024.
Our Trading Strategy
As Q4’23 Earnings Season draws to a close, the market’s focus will return to the Fed and the projected path of monetary policy. The build-up in speculative risks, investor complacency and compressed volatility leaves the market vulnerable to a sizable correction in the coming months. We see that correction taking SPY to $478 or lower (-6.5%).
As a consequence, our main focus remains profit taking and reducing risks in portfolios. At current prices, deploying new capital into the market doesn’t really make sense.
We’re yet to see a meaningful rotation from growth to value and from large caps to mid and small caps. In our opinion, this should also occur sooner or later and our portfolio is well positioned to benefit from such a rotation.
Signal Sigma PRO members will be notified by Trade Alert of any live portfolio changes (if subscribed). If you’re not on this plan yet, you can get a free trial when you join our Society Forum. If you need any help with your trading strategy (or would like to implement one on your account), feel free to reach out!