Irrational Exuberance 2.0
Things have gotten so crazy in the markets that regulators have started mocking it.
Less than three weeks after shares of Long Island Iced Tea Corp. surged as much as 289 percent after announcing a name change to Long Blockchain Corp., the agency responsible for enforcing U.S securities law appears to want in on the action. The Fort Worth, Texas, branch of the SEC announced its new big idea on its Twitter account on Monday:
“We’re contemplating adding ‘Blockchain’ to our name so we’ll increase our followers by 70,000 percent,” @FortWorth_SEC said.
The cryptocurrency mania is far from the only example of an irrational frenzy. It's just the most obvious of examples.
For starters, it's not just the United States.
The new year isn’t even two weeks old, and already $2.1 trillion has been added to the market capitalization of global equities. The market is verging on such overbought levels that not even reliably bullish analysts can keep up with the new highs.
Optimism is upending the once-dour mood of a rally noted for the hate it inspired. The bull market, now in its ninth year, has finally reached the point of euphoria, said Morgan Stanley’s U.S. equity strategists.
“Now, we have seen a total reversal with people having a hard time even imagining how the market could decline,” they wrote in a report dated Monday.
More importantly, everyone is on the same side of the boat. Almost no one is betting against the market anywhere in the world.
Likewise, short interest on the largest exchange-traded fund tracking the S&P 500 is the lowest level on record, while shorts on the largest emerging-market fund are the lowest in over a year, IHS Markit data show.
And for those chart readers, stocks are extremely overbought.
Finally, the ultimate euphoric signal for chart watchers: the relative strength index, which tracks the magnitude and speed of price fluctuations.
The 14-day relative strength index for the S&P 500 Index, MSCI Asia Pacific Index, MSCI World Index, Nikkei 225 Index, and MSCI Emerging Markets Index are all in overbought territory. Together, the average of the gauges soared to a weekly record as of Jan. 5, according to data compiled by Bloomberg.
Amazon, for example, trading at 317 times forward earnings.
Jeff Hirsch of the Stock Trader's Almanac says there's now an 83.7% chance that equities will rise for the year. It's like free money!
Another things worth considering is who is buying.
I'll give you a hint: It's not savvy insiders.
Retail investors in the U.S. are showing the most enthusiasm for stocks since the nine-year bull market began, another signal of growing optimism as financial markets hit new highs.
Clients at TD Ameritrade added to stock holdings for a 11th straight month in December, one of the longest buying streaks for retail investors ever recorded by the brokerage.
The only fear on Wall Street is the fear of missing out.
The Cboe Volatility Index (VIX.X) dipped below 9.0 on Thursday for the second consecutive day. The index, commonly regarded as Wall Street's "fear gauge," has never before read below 9.0 for two straight days since its inception 28 years ago.
The index reached as low as 8.92 early Thursday. It's only ever fallen lower than 9.0 on seven days since its creation. Six of those seven days have occurred in the last six months, with the other happening in December 1993.
Where is all this optimism coming from?
Partly from Republicans. They are absolutely giddy.
"2017 was the most remarkable year in the 45-year history of the NFIB Optimism Index,” said NFIB President and CEO Juanita Duggan. “With a massive tax cut this year, accompanied by significant regulatory relief, we expect very strong growth, millions more jobs, and higher pay for Americans.”
The Optimism Index for last month came in at 104.9, slightly lower than the near-record November report but still a historically exceptional performance. That makes 2017 the strongest year ever in the history of the survey. The average monthly Index for 2017 was 104.8. The previous record was 104.6, set in 2004.
"We’ve been doing this research for nearly half a century, longer than anyone else, and I’ve never seen anything like 2017,” said NFIB Chief Economist Bill Dunkelberg. “The 2016 election was like a dam breaking. Small business owners were waiting for better policies from Washington, suddenly they got them, and the engine of the economy roared back to life."
Uh, right. You would think that small business owners would be knowledgeable about economics, and not substitute politics for hard facts, but that doesn't seem to be the case.
However, there are savvy investors that aren't caught up in the mania. They are deal in bonds.
U.S. equities responded to the Trump presidency with euphoria. The Dow Jones Industrial Average rose 25 percent in 2017, becoming one of the best-performing global asset classes. It was a different story with U.S. Treasuries: The yield on 10-year notes fell slightly from 2.44 percent at the end of 2016 to close 2017 at 2.41 percent. And the spread in yield between two-year and 10-year notes, often a signal of slowing growth or forthcoming recession, plunged from 125 basis points to 51.8 basis points at year-end 2017.
As they receive different messages from equities and Treasuries, investors should pay particular heed to the bond market in making asset-allocation decisions for 2018. Treasuries have been a better predictor of the two recessions in the 21st century -- the first lasted from March to November 2001, and the second from December 2007 to June 2009. In the case of the latter, yields plunged during the months before the recession whereas equities remained strong well into the first half of 2008 when the economy was already in a downturn.
There is good reason to believe Treasuries are sending a warning now.