Mania Knows No Bounds
This stock market can’t go down. It only goes up. S&P 500 increased 1.5% on Wednesday even though it came into the day showing extreme greed on the CNN fear and greed index. S&P 500 is now up 10.84% on the year. It has officially been a better than average year which few expected this spring. In fact, before the recession hit, some projected stocks would rise about 5% this year. That was too bearish, while predicting a stronger economy. If we would have known a recession was coming, we would have likely predicted much worse returns.
CNN fear and greed index rose 2 more points to 78 which is still extreme greed. It's highly likely the NAAIM index is going to be above 100 for a record long 4 weeks when it comes out tomorrow. As you can see from the chart below, the S&P 500’s 14 day RSI is above 80 as it is nearly at the January 2018 peak. 2.5 years ago, when sentiment was this euphoric, that was the peak for the cycle.
Technically, that was correct because we are in a new bull market. However, we never expected we would get back to these heights so quickly. Current euphoria won’t likely be matched for the rest of this cycle. 14 day RSI and 4 week average of the NAAIM index likely won’t get this high for several years.
Part of the reason January 2018 was the sentiment peak of the cycle was the very high percentage of bulls and low percentage of bears in the AAII individual investor survey. This sentiment peak is wildly different from that one as the individual investor survey has been showing more bears than bulls for a record long time. That continued this week as the percentage of bulls fell 1.3% to 30.8% and the percentage of bears rose 2.1% to 41.8%.
August AAII asset allocation survey shows investors’ exposure to equities is at a 6 month high and cash is at a 6 month low. Stock and cash allocation were 64.8% and 16.3%. That’s similar to February when stock and cash allocation were 66.1% and 14.8%. We are very close to that euphoric peak.
VIX Continues To Confuse Investors
Investors are infatuated with the VIX for good reason because it has been rising along with stocks. It increased 45 basis points to 26.57 on Wednesday. That’s extremely unusual. Some traders might be worried about a contested election. Investors are more worried about the euphoria in the stock market. The chart below puts a dot for each of the top 20 highest VIX readings at S&P 500 record highs. Most of the dots are in 1999, 2000, and 2020. This market is just like the late 1990s/early 2000.
Details Of Wednesday’s Action
Some of the hottest stocks fell on Wednesday, yet the market still went up. No matter which group of stocks lead this market, it almost always goes up. Cloud index fell 1.56%, but the cyclicals saved the day as the industrial sector rose 1.7%. Small cap value and the Russell 2000 rose 0.9%. Nasdaq 100 and the Nasdaq both rose 1%. That was surprising because Apple and Tesla fell. Nasdaq was helped by Facebook and Alphabet which have been the least loved of the FAANG stocks in recent months. They were up 2.4% and 4.1%.
In the morning, it looked like Apple and Tesla stocks would crash, but they didn’t. Apple fell 2.1% on the day as it rose 3.3% from its morning low. Tesla fell 5.8% as it rose 9.6% from its low. Dip buyers are eventually going to feel the wrath of a terrible bear market in the tech stocks. That decline will start this month. Shopify fell 5.3% as it didn’t get the benefit of dip buyers. Zoom was the same as it fell 7.5%.
What Does An Apple Decline Mean For The Market?
If Apple were the crash, it wouldn’t necessarily tank the market. It has fallen in an up market before. However, in this case, it will coincide with a correction. Apple will fall with the other high flyers. Plus, even the cyclicals are starting to get overbought. Only the banks and energy aren’t showing signs of euphoria. They make up a very small percentage of the market. Energy is down 42% and tech is up 38% year to date. That’s an enormous 80 point gap.
The chart below shows the S&P 500’s performance after Apple closes down more than 1% following a gap up of more than 1%. Yes, even though Apple fell in the morning, it opened up. As you can see, there are only 6 signals in the past 38 years. In the next 2 weeks, the median S&P 500 return is -2.7% and none were positive. Keep in mind, Apple is much more important to the market than it was in the 1990s and 2000s. Apple and Tesla are the 2 leaders.
Everyone is wondering if they should go to cash before the bubble bursts or if they should invest in safe stocks. Consumer staples outperformed on Wednesday in part because of Brown Forman’s great quarter which sent its stock up 10%. Consumer staples rose 1.8% and Coca-Cola rose 4.2%. As you can see from the charts below, when the Nasdaq fell over 50% from March 2000 to January 2001, the bank index rose over 50%.
Same thing will happen when this bubble bursts. Yield curve will steepen, yields might rise slightly, and the default rate will fall. Allowance for loan loss rate will fall as the economy gets back to normal. This might be a better environment for banks than 2000-2001 as the housing market is on fire and banks have plenty of low cost deposits. Therefore, some investors would rather own the banks than cash.
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