If you hear T-A-P, start selling … just in case an E-R follows.

 DJIA:  30,603

If you hear T-A-P, start selling … just in case an E-R follows.  Powell’s comments didn’t suggest taper is coming.  Then, too, you just can’t have it both ways – recovery and a Fed stoked market.  The havoc of the latter is clear in a word, GameStop (194).  A few years ago we had dinner with the man who put together Activision (91), and asked what he thought of GameStop.  His answer – think Blockbuster.  In the one or two years we’ve been doing this, we’ve always found short sellers better than most analysts.  We’ve also always found that when people talk about running the shorts, they miss the point. You don’t run the shorts when the stocks are going their way.  As GME has made clear, that’s the key.  Whether it’s the short-sellers, the cryptos, or whatever, the real point is that speculation is over the top.

All Gaul is divided into three parts, we seem to recall from our high school Latin class.  Our style of technical analysis basically has only two parts.  The most important is momentum, or the strength of a move.  There are many measures here – stocks above their 10 day moving average for the short term, stocks above the 200 day moving average for the medium to long term. The latter should be the focus here, and around 90% it says strong market.  It’s overbought, but it’s that good overbought.  Think of momentum as a physics term, and in that construct any object with this kind of momentum is hard to stop.  And, perhaps there we should.  The other part of our style of analysis is investor psychology, what we like to call sentiment.  Here GameStop and its cohorts pretty much say it all.

We like to say momentum trumps sentiment, and it has.  Still, the excesses we are seeing now are extreme.  Investing is a matchup of greed and fear.  Bubbles happen when greed becomes excessive, and when fear ceases to exist.  Bubbles are not so much about valuations as they are the Greater Fool Theory.  In the case of GME, there really is no narrative, making it a bubble in the purest form.  It’s that condition where investor behavior is dominated solely by an attempt to sell to someone else something for a higher price.  There is no rational assessment of value.  The entire market doesn’t seem a bubble, the rally remains too broadly based.  The bubble stocks, however, have affected sentiment enough to leave the overall market at risk.  Over the last three weeks small traders have bought 60 million Calls.  That’s 20% greater than the bubble-like environment last summer.

We’re sure you’ve noticed we place little emphasis on valuations, believing stocks sell at fair value once on the way up and once on the way down. The trick is figuring out whether they will become more overvalued or more undervalued, in other words, the trend.  That said, we have come across a couple of things to suggest here, too, things may be a bit over the top.  One is a creation by the Bespoke Investment Group called the Ludicrous indicator.  It looks at US companies with a market cap of $500 million or more, that trade at a multiple of 10 or more times last year’s sales, and that have doubled in the last three months.  There are 600 companies on the list, dwarfing anything in the last decade.  You’ll be glad to know, however, the number still is half that of the dot.com era.  Another take on excess is by Goldman.  They have an index of unprofitable Tech companies which shows a fivefold gain since last March.  By way of perspective, that is more than five times the gain in the S&P Tech index

All good things must end someday, the not so good ones as well.  GameStop, of course, is a bit of both.  What we’ve seen this week is an extreme, but a natural extension of the speculation that has been going on for some time.  Powell is as much behind this as the traders.  He wasn’t close to saying taper, but had he, you could kiss GameStop goodbye.  All this, of course, is more than a little disruptive, including Wednesday’s 600 points down day, with losers close to 5-to-1.  Speculation is not new, what we’re seeing now is new, but still just speculation.  Monday saw a new high in the S&P, with only 45% of its components above their own 10 day average – a first little crack in momentum. The recent new high in the A.D. index says no big problem for now.  Still, this seems similar to last August which was followed by a 10% decline in September.  Keep in mind it’s not weakness that’s the worry, it’s any weak rally which may follow.   

Frank D. Gretz

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Goodbye Annus Horribilis

Many are calling 2020 annus horribilis (a Latin phrase meaning “horrible year”) due in large part to the spread of the deadly COVID-19 virus around the globe and its knock-on effects on the global economy. Yet despite the various challenges 2020 posed to the world, it was a good year for investors. The gains seen in the Dow Jones Industrial Average, S&P 500, Russell 2000, and NASDAQ Composite index were 7.3%, 16.3%, 18.4% and 43.6%, respectively. And as shown by these figures, the year provided excellent gains for many stocks and spectacular gains for others. Moreover, if historical precedents and Wall Street adages hold true to form, 2021 could add to these gains. For example, the Santa Claus Rally which includes the last five trading days of the year and the first two trading days of the new year, produced a small increase which is a favorable sign for the next twelve months. In addition, the market’s performance in January has had a respectable history of predicting the outcome for the entire year. Many believe the first five trading days of January predicts the month and January’s performance predicts the year. We believe January’s action is important since the liquidity generally available to investors early in the year from tax-loss selling, annual work bonuses, IRA and pension funding is typically the best of all the twelve months; therefore, January should produce a positive result for equities. If not, it is a warning. So far, 2021 is off to an excellent start.

While 2020 was a historic period in many ways, it was also record breaking in terms how countries responded to the global pandemic. Most nations boosted their ailing economies with massive fiscal or monetary support, or both. In our view, liquidity was the primary driver of equity gains in 2020. According to the International Monetary Fund, as of September 2020, total worldwide fiscal stimulus amounted to $11.7 trillion, or 12% of global GDP. In the US, the $2.7 trillion authorized by the CARES Act was direct fiscal support to the US economy and the $3.2 trillion increase in the Federal Reserve’s balance sheet provided monetary stimulus to the banking system. Combined, these policies equaled 23% of annualized US GDP. Moreover, Congress passed an additional $900 billion pandemic relief package in late December. Before lawmakers closed the books for 2020, they tacked on a $1.4 trillion catchall spending bill. All in all, the total stimulus authorized in the last twelve months is equal to 38.8% of nominal GDP. This extraordinary stimulus not only buoyed an artificially shutdown economy, but it also helped drive equity prices to record levels.  

It was also fiscal stimulus that drove the personal saving rate to 34% in April. November’s savings rate fell to 12.9%, yet this still remains more than twice the long-term average of 6.2%. A strong personal savings rate is an auspicious sign for the economy as well as for equity performance for the first quarter of 2021. In addition, with Democrats now in control of the White House, both chambers of Congress and with ex-Fed Chair Janet Yellen, a proponent of easy monetary policy, appointed as Secretary of the Treasury, most investors expect more fiscal and monetary stimulus in 2021. The Wall Street adage “Don’t Fight the Fed” will be an important phrase to remember in 2021. For these reasons, one could expect more stock gains ahead.

Still, there is a dark side to liquidity. The main risk of excess liquidity in the system is the potential of a stock market bubble. We expect the phrase “stock market bubble” to be mentioned often in 2021, however, bubbles are not well understood by many investors. Bubbles can materialize in any form of investment. The first bubble in recorded history was the Tulip Mania during the Dutch Golden Age in 1637. Bubbles are complicated and have many components, but they are almost always underwritten by good economies and excess liquidity. They are also distinctive because they incorporate a belief that the cycle “is different this time” and prices can continue to rise even as they disconnect from fundamentals. For all these reasons, including the lofty level of PE multiples at the end of 2020, we are optimistic yet cautious about 2021. It is important to remember that bubbles can persist longer than many expect. This was proven in late 1997 when equities disconnected from normal valuation benchmarks yet continued to rise until March 2000. To analyze a bubble and its growing risks, one must monitor both the level of equity ownership and the amount of leverage in the system. Bubbles typically end only after all potential investors have joined the bandwagon, households reach an over-ownership level in equities, and leverage, or margin debt, has reached its limits.

In the third quarter, equities were 25.4% of total household assets as compared to the 2000 peak of 26.4%. Equities were also 22.6% of financial assets versus the March 2000 peak of 24.2%. Given the recent gains in stock prices, it is likely that equity percentages increased in the fourth quarter and we will continue to monitor ownership levels for extremes. But ownership is apt to move higher. New investors are joining the investment world as a result of new digital venues and websites such as Robinhood.com, Stash.com, and Nerdwallet.com. From an historical perspective, many of the aspects of a bubble such as excess liquidity and new investors, seem to be moving into place. And we would also note that in early January there was a jump in bullish sentiment in the Association of American Individual Investors survey. The one-week reading of 54.0% bullishness was the most extreme since November 11, 2020 of 55.8%. Too much bullishness is not a good timing device, but this does suggest investors should remain alert in 2021.

Even so, the most troublesome characteristic of an equity bubble and the key signal that a bubble is reaching its exhaustion phase is tied to the use of leverage, or margin debt. An extreme is reached when increasing levels of leverage, or margin debt, fail to lift stock prices much higher. This is a serious warning for investors. We can monitor this by comparing the 2-month rate of change in margin debt to the 2-month rate of change in the Wilshire 5000 index. If the 2-month rate of change in margin exceeds two standard deviations (15.3%) and the Wilshire price index does not follow suit, the bubble may be in trouble. The most recent negative signals from this indicator were seen in December 1999, June 2003, and May 2007. In November, the 2-month rate of change in margin debt was 10.4% (below the 15.3% standard deviation warning level) and the 2-month rate of change in the Wilshire was similar at 9.7%. In short, there were no signs of excessive margin or exhaustion in recent data.

To sum up, while it is possible that 2021 could be planting the seeds for an equity bubble it is equally possible that 2021 could become a tricky roller coaster year for stocks. There are signs of rising inflation emanating from rising oil prices, wholesale prices and a weak dollar. More inflation could lead to higher interest rates which could trigger an equity market correction. The weakness seen in the job market at the end of the year could lead to disappointing economic data, hurt investor optimism, and stall stock prices. Given this backdrop, investors should take a multiyear view of equities and seek companies that one wants to own over the next decade. This should be both the path to profits and preservation of capital. Expect 2021 to be an interesting and volatile year.

Gail Dudack, Chief Strategist


Disclosure: The information herein has been prepared by Dudack Research Group (“DRG”), a division of Wellington Shields & Co.  The material is based on data from sources considered to be reliable; however, DRG does not guarantee or warrant the accuracy or completeness of the information.   It is published for informational purposes only and should not be used as the primary basis of investment decisions.  Neither the information nor any opinion expressed constitutes an offer, or the solicitation of an offer, to buy or sell any security.  The opinions and estimates expressed reflect the current judgement of DRG and are subject to change without notice.  Actual results may differ from any forward-looking statements.  This letter is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the specific needs of any person or entity.

This communication is intended solely for use by Wellington Shields clients.  The recipient agrees not to forward or copy the information to any other person without the express written consent of DRG.

Copyright © Dudack Research Group, 2021.

Wellington Shields is a member of FINRA and SIPC

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US Strategy Weekly: Sentiment and Inflation Warnings

One of the first warnings signs of the year was the rise in bullish sentiment reported by the Association of American Individual Investors (AAII) in their weekly survey. In the first week of 2021, bullish sentiment rose from 46.1% to 54.0% which means bullish sentiment has remained above the historical average of 38% for nine consecutive weeks. Bullish sentiment is also at its highest level since the November 11, 2020 reading of 55.8% which was a 12-month high. An early preview to current data suggests bullish sentiment may increase again in the current week. Nevertheless, the 8-week Bull Bear spread is negative for the second week in a row which is similar to the warning seen in early 2018. See page 18. As a reminder, 2018 was a roller coaster year of big price swings that ended with a loss of 5.6% in the Dow Jones Industrial Average and 6.2% in the S&P Composite.

It is important to keep in mind that sentiment indicators are not useful for timing market peaks or troughs, however they do provide good discipline for investors who may become too optimistic or pessimistic about equities. With bullish sentiment above 50%, investors should remain alert to other signs of risk in the markets. Nevertheless, most technical indicators are confirming the indices’ recent highs. The NYSE cumulative advance decline line made an all-time high on January 12, the 10-day average of daily new highs is robust at 433 and the 10-day average of daily new lows is 28, and well above the 10 or less per day that can appear at the end of a major advance. The one ambivalent technical indicator is the 25-day up/down volume oscillator which is currently neutral at 1.52. This oscillator was in overbought territory for 16 of 19 consecutive trading days between November 23 and December 18 and reached an extreme overbought reading of 5.52 on December 4. This combination was a solid confirmation of the new highs seen at year end. But if we see further gains in stock prices in 2021, we would also like to see an overbought reading to show that price gains are supported by solid buying pressure. See page 11, 12 and 13.

Last week we noted the favorable signal emanating from the Santa Claus rally given the gain during the last five trading days of the year and the first two trading days of the new year. The January Barometer, devised by Yale Hirsch of the Stock Trader’s Almanac in 1972, is another Wall Street adage that states “as goes January so goes the year.” This parable makes sense to us since liquidity, or cash, tends to at its best early in the year as a result of year-end tax-loss selling, year-end bonuses and annual funding of pension funds and IRA’s. History also suggests that the first five trading days of January predicts the month of January. On page 7 we show the performance history of the Dow Jones Industrial Average during the first five days of January, the month of January and the full year beginning in 1950. It indicates that the first five trading days of January has predicted the year’s action 79% of the time. However, the January Barometer has an even more impressive 95% accuracy in predicting the full year’s action if, and only if, January has a positive performance. The Barometer is less accurate when January ends with a loss. As the table shows, there have been 24 instances of losses in early January, 14 years with losses in the full month of January, and eleven years of negative performances for the full year. In short, January losses are far less predictive. But to date, the 1.6% gain in the first five days of January 2021 bodes well for the month and for the overall year. See page 9.

Anyone Focusing on Jobs?

The ISM manufacturing index increased from 57.5 to 60.7 in December, with most components, except for trade, also rising. Prices paid soared from 65.4 to 77.6. We remain nervous that inflation could be a big risk for equities this year. The nonmanufacturing index rose from 55.9 to 57.2 in December, but the employment index fell from 51.5 to 48.2. With the employment index below the 50 breakeven point, it suggests job growth in the service sector may weaken in coming months. See page 3.

The loss of 140,000 jobs in December did not surprise us given the extended shutdowns of businesses in states like New York and California; so, we are encouraged that Governor Cuomo appears to be ready to ease some restrictions. Still the risk of lengthy shutdowns is that businesses and entrepreneurs have been and will continue to face bankruptcy, which weakens the economy, and foreshadows more jobs losses. In December, the number of people employed was down 6.2% from a year earlier. Typically, any negative growth rate in employment suggests the economy is in the midst of a recession. The US economy has been buoyed by extraordinary fiscal and monetary stimulus for much of 2020, but stimulus cannot solve all problems. The unemployment rate in December was unchanged at 6.7%, but this is still well above the 3.6% seen in December 2019. Plus, when we look at the breakdown of unemployment, we find it is not evenly distributed. Those hurt the most in 2020 were workers with less than a high school degree which means households in the lower end of the job market remain under the greatest pressure. This dilemma is linked to the closure of food and drink establishments, hotels, and all employees tied to business and leisure travel. In our opinion, a weak job market will be another risk factor for the economy, earnings, and investors in 2021. Strangely, politicians seem focused on other matters and are ignoring this fact. See pages 4 and 5.

Small Business Confidence is Crumbling

Entrepreneurs and small businesses were feeling the impact of the pandemic at the end of 2020. The NFIB small business optimism index fell 5.5 points in December to 95.9 and all components with the exception of inventory satisfaction were lower. Owners expecting better business conditions over the next six months plummeted 24 points to a net negative 16. Sales expectations for the next three months fell 14 points to a net negative 4. Hiring plans fell 4 to 17, which was down but only to the lower end of the range seen over the last three years. This survey makes it clear that small businesses are concerned about their future in 2021.

The two areas of strength in the 2020 rebound have been housing and auto. Existing home sales were fairly robust at 6.69 million (SAAR) units in November, down slightly from October, yet up nearly 16% YOY. New home sales were 841,000 in November which was down from 945,000 units in October, but still up 21% YOY. The one warning sign we see for homebuilders is the pending home sales index which fell for the third consecutive month in November to 125.7. See page 7.

Earnings Forecasts are Stabilizing Consensus earnings estimates were revised significantly lower at year end but edged up slightly last week. S&P Dow Jones estimates rose $0.20 for 2020 and $0.17 for 2021 while IBES estimates rose $0.13 for 2020, $0.36 for 2021 and $0.37 for 2022. The S&P Dow Jones and IBES estimates for 2020 are $120.54 and $135.79 and for 2021 they are $164.57 and $167.61, respectively. Keep in mind that PE multiples have expanded dramatically in the last twelve months due in large part to low interest rates and indications from the Federal Reserve that monetary policy will not change before 2023. However, our valuation model indicates that the current low inflation/low interest rate environment translates into a 20 PE multiple. If we apply a 20 PE to the IBES $167.61 estimate for this year it implies a target for the SPX of 3352. In other words, the SPX has a 12% downside risk should optimism regarding earnings, the economy, interest rates or inflation change in the near term.

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If you forecast for tomorrow what happened today …

DJIA:  31,041

If you forecast for tomorrow what happened today … you’re right some 70% of the time.  And now you know all you need to know about forecasting the weather.  As for the stock market, that’s different.  Arthur Burns suggested the secret to forecasting is to keep forecasting.  Keynes seemed to agree, saying when things change he changes his mind.  The philosopher Mike Tyson perhaps sums it up best – everyone has a plan until you get hit in the mouth.  Keeping in mind you get what you pay for, our two cents is that it will be a good year, but a different one.  While there are signs of euphoria and valuations that arguably are stretched, the technical backdrop remains sound – hence, a good year.  History, however, suggests a different one.  It’s likely to be one of more muted gains and one with a different type of leadership.

The S&P was up 16% last year, and 29% in 2019.  It is rare for the market to be up 10%+ three years in a row.  Similarly, Tech stocks have had back to back 40% gains.  Against that backdrop, it is rare that any group does not underperform the following year.  We offer this not so much as a forecast, but rather an observation.  The NAZ was up 40%+ last year and more than 50% of that was Apple (131), Tesla (825), Amazon (3165) and Microsoft (218).  It’s not hard to see how any underperformance by Tech could hold back the averages.  Meanwhile, it’s easy to see how the forlorn infrastructure stocks like United Rentals (264) and the metals and mining stocks could lift the market without giving a big boost to the averages.  We’re still positive on biotech, and gold finally has shaped up – silver even more so.  And those energy stocks you’ve been meaning to sell, suddenly have come in handy.

If you saw The Graduate, surely you remember – plastics!  Our update on that is – lithium!  As measured by the Lithium ETF (LIT – 73) and the many stocks here, lithium has been on a tear.  The main driver for lithium and materials like cobalt and rare earth elements is electric vehicles.  Then, too, lithium isn’t exactly new.  Your smart phone, your laptop, your tablet are all devices that rely on lithium.  It’s electric vehicles, however, that seems behind the recent run.  Bloomberg forecasts sales of electric cars will hit 41 million by 2040, representing 35% of all global new car sales.  While EV sales in the US jumped 81% in 2019, that’s a drop in the bucket compared to China where EV sales topped 1.2 million cars.  You may not want to build your portfolio around lithium, but it should have a place.

If lithium is not to your liking, maybe we can interest you in a little Solar.  Solar and its ETFs like the Invesco Solar (TAN – 121) and the iShares Global Clean Energy (ICLN – 33) have done quite well.  Components like the Daqo Energy (DQ – 80), have done even better.  We have thought of Solar as a hedge against the Georgia election, but that seems overthinking.  Chinese President Xi Jinping, a man you can trust, has pledged to make his country carbon neutral by 2060. There’s many a slip twixt the cup and the lip, and by then we just might be old.  Still, given that China gets two-thirds of its power from coal, the implications are almost staggering.  China has created seven of the world’s top 10 Solar module manufacturers, according to Wood Mackenzie.   Like lithium, Solar may not be something you want to build a portfolio around, but something that should be part of it.

So how about the market’s reaction to the Georgia election outcome?  The NAZ, that is Tech, did selloff, but on the NYSE breadth was more than respectable, and on the NAZ it was even better.  A surprise, or validation of one of our long held beliefs – when it comes to the stock market, what we all know isn’t worth knowing.  And there is a rationale, well expressed by Nicholas Colas of Data Trek.  If you ask CEOs how they feel about a two point hike in their tax rate in return for a $2 trillion stimulus plan, they’re more than good with it.  Amidst all that is going on, best to keep in mind the basics.  For all that can be worried about both in and outside of the market, most days most stocks go up.  When that changes, then heed the Keynesian advice.  Meanwhile, as we suggested above, this year could be different.  If you look at the charts, should you own Microsoft (218) or, of all things, US Steel (20)?

Frank D. Gretz

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