We have been getting that feeling more and more that bear markets are a think of the past. That maybe they have been deemed illegal by the “powers that be.” But then we have to remind ourselves that this is what a top feels like.
We have talked about a couple of different hedging structures this past month. But the broad market averages have traded higher, so hedging is a strategy that is a bit premature. But we thought we might take a look at a few charts that show just how overextended the equity market is at the moment.
The first chart compares the Value of Equities (in millions) to US GDP (billions). It shows us that equities, relative to GDP, are the most overvalued they have ever been.
One of the big reasons, of course, is the Fed’s asset purchases and the super-low interest rates that have resulted. There is no reason to buy long-term government or investment-grade corporate bonds. They are certain to be certificates of confiscation. Super-low interest rates are encouraging companies to issue debt and use the proceeds to buy stock.
There is a second phenomenon that is worth talking about. Rising stock prices are reinforcing the bullish confidence individuals are feeling. People who have been irresponsible and speculating on tech stocks with no earnings have been reward with higher stock prices and trading profits. The government’s instance of doing helicopter drops of cash is encouraging people to speculate as well. Confidence is running so high that people are borrowing money to speculate on stocks.
The chart above shows that investors have borrowed close to $400 billion to buy stocks. If and when share prices begin to fall, this will act as an accelerant to the selloff. The rise explains where bulls are getting some of their fire-power. It is not coming from savings. People are borrowing with gusto. Notice the number has increased by about $50 billion since the turn of the year.
The rampant speculation is showing up in the trading volume statistics. Trading volume is running at 3 to 4 times the historical averages. If this does not spell s-p-e-c-u-l-a-t-i-o-n, I do not know what does. Oh, maybe the following chart might drive the point home.
Trading in call options is also off the charts. Call potion trading has not popped to 2 to 3 times the regular activity. We suspect that people are trading options as a leveraged speculative vehicle. This is another source of financial leverage. One that does not show up in the margin numbers.
There is another data point that caught our eye. Cathie Woods, the CIO at ARK Investments, has been killing it. She has made big bets in large-cap tech, crypto, and exponential stocks, which has turned out to be a great move. Check out the returns of the ARK Innovation ETF (ARKK). These numbers are incredible.
According to Yahoo Finance, this ETF returned 153% in 2020, and 2019 was not too shabby at 36%. 2017 was also an incredible year, with ARKK delivering an 87% return. This performance is not going unnoticed. ARK Investments assets under management grew to $50 billion. Everybody wants in.
Everything seems to be going to an extreme. The charts in this note show that the equity market shows signs of greed and euphoric top. When this bubble pops, we will be looking to a move from top to bottom of at least 50%. The big challenge is timing. The charts discussed above show us the elements of a big-time top are in place. But that does not mean that prices cannot go higher. Price always seems to go farther than one can imagine.
The Federal Government is preparing another helicopter drop of cash. We are sure billions will find their way into the stock (and crypto) markets. Some have argued that the recent rally is buying in advance of the checks. If that is the case, the bill’s passage may be a “buy the rumor, sell the news” situation. This could be the catalyst for a top. Simultaneously, the money drop could be so significant that it keeps share prices up for a few more months. Time will tell.
Now is the time to begin taking profits and reducing bullish exposure. When the bear comes out of hibernation, you will be glad you are not fully invested. With some dry powder in hand, you will be able to buy a significant dip.
