The stock market has continued to rally from the March panic selloff and it has made up most of the loss from June 11. The rally has been impressive and it has surprised a lot of people, including me. I have written several articles about what I think is driving the market and have made some comparisons to the dotcom rally that we saw in the late 90s and early 2000s.
As impressive as the rally has been, it appears to be rather fragile at this time. Late Monday night, S&P futures plunged as White House trade advisor Peter Navarro told members of the press that the U.S.-China trade deal was “over”. Futures plummeted rapidly and within an hour or so President Trump, Larry Kudlow, and Navarro himself had walked back the comments. The comments calmed investors and by Tuesday morning futures were sharply higher.
Regardless of whether or not Mr. Navarro’s comments were taken out of context as he stated they were, the reaction by investors was an indication to me that investors are ready to bail on the current rally. And they are willing to do so in a hurry.
To me, there is good reason for investors to be ready to bail on the current rally. We have seen the rally move abruptly and it has moved in shifts with sectors like tech, consumer discretionary, and healthcare leading the first part of the rally through mid-May. After the first phase of the rally we saw sectors like energy, industrials, and financials lead the way for about a month. In the last week or so it appears that there has been another shift and tech, materials, and communication services leading the way after the June 11 plunge.
From my perspective, the rotation back to the last three sectors I mentioned is a positive sign. The tech sector has some of the best fundamentals, as a whole, of all the sectors. This is part of that process I talked about in my Flight to Quality article. Even though I view the most recent shift as a positive, there is evidence that things have been overdone on the rally.
An article from Bloomberg Tuesday morning showed various measurements of valuations and how overvalued stocks are at this time. There were also numerous analysts quoted. One analyst comment that got my attention was from Chris Watling, chief market strategist from Longview Economics. Mr. Watling stated, “Everything is expensive, 80% of the markets we track have a valuation in the upper quartile relative to the market’s history — the greatest percentage on record using data since the mid-1990s.”
Another excerpt from the article caught my eye as well:
Dotcom Deja Vu
After a more than 40% climb in stocks from the trough of the coronavirus-driven slump in March, global equity valuations have surged to their highest since the dotcom bubble of the new millennium.
That excerpt to my attention because of comments I have made in my own articles. Specifically how investors are so exuberant about the gains they’ve made and how “printing money” has appeared too often in my social media feeds.
One aspect of the rally that I have been hearing more about was the M2 money supply and how the Fed’s actions have done a great job of boosting the market in the last three months. I saw a chart on Bloomberg TV that showed how the money supply and the S&P have moved in synch in recent months. Unfortunately the best chart I could muster to show something similar was from TradingEconomics.com. The chart below shows money supply and the Dow on the same chart over the past year.
As you can see the trajectory of the money supply turned sharply higher in March and has continued that path in April. We haven’t gotten the May figures yet, but you can bet the trajectory remains sharply ascending.
The monetary and fiscal policy changes in the U.S. have definitely kept the market and the economy from tanking, there is no arguing that. My concern is, how long can the Fed and the federal government continue to prop up the market and consumers? Obviously the Trump Administration will do everything in its power to keep the market and the economy going through the election in November, but even then it might not be enough.
Another comparison I keep thinking about with the current rally and the dotcom rally is how they compare in terms of the calendar. The dotcom rally came to an end in an election year—2000. There was also a sharp increase in volatility in the first half of the year in 2000. The S&P fell from over 1,550 to around 1,340 in a four week stretch. That 13.5% plunge doesn’t compare to the plunge we saw in February and March, but it was rather noticeable back then. There was another smaller selloff in July of that year, right around the time second quarter earnings results started to come out. The beginning of the end came in October as third quarter earnings results started coming out.
We will be entering the next earnings season here in a few weeks and then the third quarter results will start to roll in come October. I urge investors to take some precautions with the current market. I hope we don’t go through another bear market like we experienced from 2000-2002, but there are a lot of similarities that are starting to stack up.