THIS IS A MARKET AT EXTREMES
TPA’s models have worked well for the past 11 years. Recently, we have had more trouble and that seems to be because of the nature of the recent rally. There is a lot of evidence to show the extraordinary condition of the current market, but in this report TPA will discuss just two of the reasons.
PICKING UP THE TRASH
There is evidence that investors have been buying beaten-up stocks instead of buying good companies. The winning stocks until about 3 months ago were large-cap growth stocks. This made sense as these stocks were somewhat insulated from the pandemic, had leverage or a monopoly in their respective industries, were profitable and were growing. The winners in the past 3 months do not share these admirable qualities.
The relative performance chart below shows TPA’s BIGTECH Index (top 8 stocks in the Nasdaq 100) and the S&P500. BIGTECH peaked in early September and, unlike the S&P500, it has not regained its old high. TPA has discussed previously and is now sure that much of the rally in the past 3 months has been due to a reallocation of some of the money that used to be in BIGTECH to other parts of the equity spectrum.
TPA warned clients about this in the 9/3/20 World Snapshot. In the recent 11/24 World Snapshot, TPA told clients that since TPA BIGTECH made up over 25% of the Russell 3000 and over 31% of the S&P500 on 9/2/20, a small reallocation out of BIGTECH would have an outsized effect on many stocks, “This change in behavior has been negative for BIGTECH and Momentum stocks in general, but due to the outsized nature of BIGTECH, it was actually extremely beneficial for a wide swath of other stocks.”
TPA looked at the top 2500 stocks in the U.S. to compare their 3-month percent move to their 1-year earnings* growth rate (*EBID). The results in the table below show conclusively that the stocks that moved the most in the past 3 months had the worst earnings growth.
The top 250 stocks were up an average of 83%, but had 1-year earnings growth of -43%. The top 500 stocks by 3-month percentage move have been up 61% on average but have 1-year earnings growth of -29%. By contrast, the bottom 500 stocks by 3-month percentage change have been up just 1.35% in the past 3 months, but they have 1-year earnings growth of over 13%. (see all the data in the attached report).
Of course, it is a good idea to look for stocks that have been down and are good values, but the concern should be if investors were just buying stocks because they were down regardless of the stocks’ prospects. The latter strategy is unsustainable.
EQUITY ALLOCATIONS ARE AT HISTORIC EXTREMES
Investors are betting much more heavily on stocks now than is normal. Goldman Sachs discussed the extreme equity allocations a week ago. The table below shows that equity allocations have reached the 97th percentile looking at historic data back to 1990 or the past 30 years. Households and Foreign investors seem to be at the greatest extreme, while even mutual funds and staid pension funds are at the 68th and 77th percentiles looking back 30 years.
CONCLUSION
Buying stocks at a time when investors are at extreme equity allocations and are buying stocks with questionable earnings prospects does not seem to set up a positive outcome for the stock market.