Trading the Indices on Fundamentals

[FXtrader8911]

Fri saw the dip buyers waking up big time with the DOW swinging 900pts reversing its day start at -1% to end at +2%, the Small Cap was even more impressive going from the day's -3.2% to +1.5%. The NQ also lifter from a -12% correction closing at -8% from its high. All this on a day that, in terms of fundamentals, nothing happened!

Gamification is back in play, the individual Reddit trader with $4t of free money in hand has enough clout to break the fund manager's strategy that's working on fundamentals of the real world. These gamers turned traders move as a herd, often not knowing what they are buying but their action can none the less elevate share prices beyond any justification based on earnings or even capitalization.

The Buffett indicator has gone back above 190% of GDP and will probably get to 200% soon. Can current market levels be justified by saying that earnings will catch-up to the PE? I say... not a chance in this decade! Why? because if the real economy was as good as the markets make it out to be, there wouldn't be a need for $4t in stimulus and even with $4t in stimulus, GDP is not going to increase by 60% in a decade (remember that unemployment is currently above what it was during the great recession), however, as the saying goes... Don't fight the Fed, if markets want to be irrational then don't fight them either.

The bottom line is that, at the end of the day, markets are efficient and will sooner or later reflect fundamentals of the real economy.... when the Reddit herd and bit coin millionaires have all bought their Lamborghini and the helicopter money stops, the only conclusion is that a massive correction will happen. Perhaps the NYSE should be setting circuit-breakers based on the Buffett indicator instead of daily moves.... a 40% to 60% correction is not good for anybody, so the NYSE should have a mechanism that decreases its eventuality.

 

[Laissez Faire]

The bottom line is that, at the end of the day, markets are efficient and will sooner or later reflect fundamentals of the real economy.... when the Reddit herd and bit coin millionaires have all bought their Lamborghini and the helicopter money stops, the only conclusion is that a massive correction will happen.

It seems to me that claiming markets are both efficient and that stock prices are inflated are contradictary statements.

I don’t think markets are efficient and I also think this is one big bubble.

 

[FXtrader8911]

It seems to me that claiming markets are both efficient and that stock prices are inflated are contradictary statements.

Indeed, claiming that markets possess an efficient mechanism while admitting that prices are currently inflated is contradictory, but I did not say that markets are in a constant state of efficiency. In fact, most of the time prices overshoot one way or the other as sentiment often overrules common sense, however, the market's efficiency mechanism will eventually gravitate prices towards fair value. The important take away is that markets have an efficient way to determine what is fair value and will always gravitate to that value eventually. An investor should recognize this and not enter into positions when prices are inflated as this will result in a negative long-term return... i.e. erosion of capital rather than the creation of wealth.

 

[Laissez Faire]

Indeed, claiming that markets possess an efficient mechanism while admitting that prices are currently inflated is contradictory, but I did not say that markets are in a constant state of efficiency. In fact, most of the time prices overshoot one way or the other as sentiment often overrules common sense, however, the market's efficiency mechanism will eventually gravitate prices towards fair value. The important take away is that markets have an efficient way to determine what is fair value and will always gravitate to that value eventually. An investor should recognize this and not enter into positions when prices are inflated as this will result in a negative long-term return... i.e. erosion of capital rather than the creation of wealth.

I think the last few years and especially 2020 have been the ultimate f''k-you to fair value and efficient markets. The only thing which seems to matter are yields and money flows.

The conclusion can't be any other than that markets are inefficient most of the time and largely as a consequence of central banks intervening in the free market mechanism.

If the bobble eventually bursts (like it did in March 2020) and the market eventually reaches 'fair value' - cheap money is ready to buy again and will drive it once again to ridiculous heights.

 

[tayte]

...
If the bobble eventually bursts (like it did in March 2020) and the market eventually reaches 'fair value' - cheap money is ready to buy again and will drive it once again to ridiculous heights.

That makes a lot more sense to me than the "gonna crash sooner or later" talk. We've seen what JP's willing to do to keep Fair Valuations at a steady climb, it's just highly unlikely we'll see any prolonged selling for a while.

 

[FXtrader8911]

There’s plenty of evidence of euphoric thinking right now. The Reddit traders were with their finger on the BUY button and hit it as soon as the $1.9t bill was passed, even before receiving the $1,400 cheque. Robbin Hood founder added to the euphoria by announcing that his clients made $13b in the last 6 months. His statement was careless in my opinion, it reinforced the Reddit crowd's thinking that stocks can only go up so they automatically buy the dip. Those with more than a year’s experience in markets know this is both untrue and dangerous.

Fund managers are saying that the recent spike in bond yields is to be watched, claiming that the turning point for the Fed to change its tune is when yields hit 1.7% (They hit 1.61% y'day). Their reasoning is that the Fed's inflation models are flawed in not factoring the portion of the $4t of free money that by and large has not been targeted to the economy but rather have gone to individuals (Something that the former Treasury Secretary, Larry Summers, repeatedly warned on). According to these experts, even a .3% increase in Fed rates will challenge the belief that earning will grow into the PE within 2 years.

A more drastic view is that of the Chinese Party believing that America is heading the way that broke the back of the USSR. They believe that adding another $4t to $6t in infrastructure spending to the already spent $4t in stimulus will put the USA in a financial meltdown that will affect all areas now dominated by the US, including becoming a diminished military power. The Chinese believe that all they need to do is wait for America's disintegration to then become the top-dog.

I don't subscribe to the Chinese view, however, neither Powell nor Biden have addressed the problems an $8t to $10t of debt could cause to the economy, so, at least within the perspective of the markets, it is time to look at the reality and don't get caught up in the euphoric thinking.

 

[FXtrader8911]

As was mentioned in the 12th post, Bond increasing yields are worrying some fund managers. Powell did not adequately address this in his last talk, in fact, Powell said that the Fed would no longer act on inflation projections but rather act on the data itself, this added to the worry of market watchers who believe inflation could run out of control. The current tug-a-war between the retail dip-buyers and the professional money managers continues, the recent approval of the $1.9t aid package has replenished the ammunition of the retail trades. My view is that the professional will win the game and markets are due to settle on what the fundamentals say the price should be, it might take some time for that to happen though.

 

[FXtrader8911]

The last 2 weeks should have been good for the day traders that know what they are doing... 400pt daily swings on the DOW have been the norm. As for the indices themselves, both the NQ & RUSSELL are very close to correction territory while EU and Asia have lost the wind in their sails that was pushing them to the Pre-Covid levels, only the NIKE225 had surpassed previous highs but it too has now eased off by 6% The FTSE100 & HSI are still 15% below Pre-Covid highs.

 

[FXtrader8911]

I have been anxiously waiting for this reporting season. So far, markets have responded as expected i.e. although earnings mostly beat consensus, forward guidance is not justifying the valuations players have given. Markets prices are on average 25% above historical PEs and the forward guidance of the reporting companies do not show that they will grow into the market's PE expectation, in fact, several companies that did say the 2nd quarter will be even better than the 1st, did warn that the trajectory of growth is not expected to apply to the 3rd and 4th quarters.

The failure of markets to make new highs might also dampen the sentiment of the Robbin Hood crowd, thus allowing fund manages to regain control and keep prices more in line with realistic expectations.

We are still in interesting times, however, we might have seen the end of the relentless buying (mindless buying in my opinion) that has been happening for the whole of 2021. I have gone mildly short US and Long EU.

 

[murray t turtle]

It seems to me that claiming markets are both efficient and that stock prices are inflated are contradictary statements.

I don’t think markets are efficient .......................................

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Sounds + looks like like they are not efficient or inflated today/...............................................................................I dont really expect 4 weeks of selling like we had a year r 2 back on charts.