Minimal Decline On Thursday - Cloud Is Still In A Bubble

Down But Not Really

The stock market fell on Thursday, but it didn’t feel as bad as the S&P 500’s 0.78% decline indicates. Russell 2000 was actually up 5 basis points. Considering how overbought the market was on Wednesday, you can say this was a light decline. You can also say that means a deeper decline is coming. Latter is likely the case. None of the companies I personally follow were down more than 2% on Thursday.

On every prior decline we’ve had in the past few weeks, there have been many stocks deep in the red. Boeing, which had been a big loser through much of the recovery since the bottom was actually up 4.21% to $139. Shopify was up 3.13% because it literally goes up every day. It’s now at $802.35 which is a 96.75% increase year to date. 

We haven’t had close to the volatility necessary to end this bubble in cloud stocks. In fact, there was only one day this week where they underperformed. They either fell or were flat on Monday. That’s not enough to end this. This won’t be a smooth ending where stocks rally back to the peak and momentum tech stocks lag. We are about to see sharp volatility in these stocks.

IT Dominates Industrials

Technology stocks are doing because this is the number one theme in markets. Euphoria knows no bounds. Big tech stocks have much better business models than the ones in the 1990s. Even the small cloud stocks of today are better businesses than the companies in the 1990s. However, some are now bearish on these names because we are seeing classic bubble behavior. It doesn’t matter what the company does. If the valuation is too high, it will come down.

Even Clorox, which is a boring good business can be a bubble if enough speculative buyers drive it to the moon. We’ve seen many portfolios with only technology stocks. Investors are completely ignoring diversification and chasing the winners. They are doing this because it has worked. People mimic what works. 

Someone who bought more Shopify after it doubled actually made even more money. It’s like if a pilot gets away with doing a crazy trick and goes back for more. Investors need to be taught a lesson about speculation. They are getting rewarded for bad behavior.

As you can see from the chart above, the cyclically adjusted PE ratio of the IT sector is about 1.6 times the MSCI all country world index. In the other hand, the industrials are at about 0.9. Even though it doesn’t look like a big deal that the industrials are slightly cheaper than the rest of the world, it is a big deal. American market is much more expensive than the rest of the world. If you think American stocks are overvalued, don’t short the S&P 500. Short the tech sector. Industrials are cheap.

No Dividend Wins

As you can see from the chart below, the high dividend yielding stocks haven’t rallied much off the low, but the no dividend stocks are near their high. There are a few factors in play here. First, since so many dividends were cut, paying a dividend is potential ammo for a move lower. 

Secondly, utilities and consumer staples (dividend payers) haven’t rallied as much off the low because they are conservative plays. Finally, the tech stocks which don’t pay dividends have done very well. Work from home cloud stocks and the online shopping stocks don’t pay dividends. Most charts a reflection of the fact that tech stocks have done well. Whatever characteristic tech stocks have has done well.

Earnings Don’t Matter?

The chart below seems to indicate earnings don’t matter. As you can see, the S&P 500’s EPS estimates usually have a 0.9 correlation with the S&P 500, but there is a -0.9 correlation since the bottom. Earnings will always matter. An issue with this chart is usually stocks are in line with estimates. 

Because we knew the economy was cratering before estimates had a chance to come down, the decline wasn’t in line with estimates the way it usually is. Estimates clearly matter because the companies the least affected by this shutdown and the few that are helped by it are seeing their stocks explode.

Review Of Thursday’s Action

Big cap stocks underperformed the small caps on Thursday. Nasdaq actually fell 0.97% even though Shopify and Tesla were up. Tesla stock rose 1.48% as it is nearing its record high. It’s only down 9.79% from the previous peak. Tesla isn’t a part of the cloud tech stock bubble, but it might fall in sympathy when that bubble pops.

Every sector fell except the industrials which was up 17 basis points. Boeing led it higher. Worst sectors were energy and tech which fell 1.48% and 1.4%. National Oilwell Varco stock fell 6.77% because it stopped paying its dividend. 

Once again, it's shocking that the stock fell on such news. Did anyone think they could pay the dividend? This is just like how Urban Outfitters stock fell on its bad quarter. Urban stock rose 6.59% on Thursday as people realized a clothing retailer doing bad should be expected.

Conclusion

The stock market fell modestly on Thursday. It’s not done falling. The market hit a euphoric level on Wednesday. We need more than a slight decline to clear the optimism away. Cloud stocks are likely getting ready for a big decline. Personally, I wouldn’t buy any of these names. 

If you’re a long term bull, you will be able to buy some of them 20% lower in the next few weeks. Euphoria is on levels consistent with bubbles. They are good businesses, but everyone owns Amazon which is a problem. 

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