Stocks Gone Viral

Now that stocks have temporarily been released from quarantine, led by the TSLA rocket ship, the blissful equity bubble is back on. And in terms of stock selection, the less economically sensitive the better. The heaping quantities of stimulus, both existing and promised, are tempting a collective attempt to catch the falling stock knife. And not having a clue what comes next in the unfolding virus crisis doesn't seem to faze investors this morning.

Second sober thought may prevail at some point, as the economic demand shock filters through the data. But the mild sell-off in the broader averages reflects the changing composition of the S&P 500. Late yesterday, the market reversal of the Friday decline was led by technology, semis and financials. The huge market caps the likes of Microsoft and Google are masking the economic sensitivity of the entire market. Absent a recession, these companies are immune to the short term economic weakness brought on by the likes of a trade war let alone an isolated viral outbreak that, like the 2003 SARS experience, is ultimately transitory.

And TSLA exemplifies the FOMO, short-squeeze, momentum chasing, ESG world we are dealing with. Forget the fundamentals of the stock. This is a short squeeze plain and simple. This company is the Pets.com of this cycle. And being led by a dope smoking dreamer only gives it more street cred with the disruptive investor crowd.

The average stock, if there is such a thing in this increasingly heterogenous stock market, was weaker than the cap weighted index. The chart below shows the cap-weighted index versus the equal-weighted index price performance.

Needless to say, the crowding into the mega cap winners has reached the excesses last seen during the technology bubble of 1999-2001

S&P 500: Cap vs Equal Weight

I will say it one more time - stocks are a monetary phenomenon. And with the demand shock from the virus threatening, China and the world have responded. More money is coming.

Bond yields are now well below inflation, meaning stocks are still the preferred asset class. In this case, TINA trumps Fear.

The narrowing of the sources of performance is indicative of too much money chasing too few stocks. It is the hallmark of the final stages of an equity bull market. We need a broadening participation from the lagging sectors, Basic Resources, Emerging Markets and Energy. I think we will still get it this year.

Because of the sudden appearance of a black swan on the economic data pond in the form of Coronavirus, the increasingly popular aversion to economically sensitive equities has reached new extremes. The chart below demonstrates how stretched this aversion became over the past two weeks. It shows the relative performance of Utilities to Basic Materials. This was a chart that most observers, myself included, thought had definitively peaked in October 2019. A truce in the trade war and a bottoming in global growth data at that point was thought to be sufficient for such a peak in Q4. Now with the serious threat of a demand shock due to the H5N1 virus, all bets were covered. It looks to have peaked.

Utilities vs Materials

But I smell opportunity here. With the SARS crisis, the health authorities as well as the market were totally unprepared. Now, armed with the experience of 2003, and dealing with a less viral outbreak than SARS, the playbook of a "V" shaped recovery is becoming a real possibility.

That would be extremely bullish for the lagging groups. The speed bump that has hit the market will fade into the rear-view mirror as investors rebalance from an extremely overbought defensive posture. I anticipate the anticipations of others to become more constructive as they look over the viral valley that has unfolded unexpectedly.

Late week commentators capitulated faster than a Tesla short seller. Jim Cramer, never one to look offside, panicked out of his oil stocks, recommending instead investors buy the makers of surgical masks. Bearish economic calls multiplied as fast as the Corona virus. Cue the contrarian bets.

I also received a 'cab driver buy signal' in the form of a worried reader who sent me the Globe and Mail article on the Baltic Dry index collapse. A notoriously volatile and coincident indicator that became trendy to follow in the last commodity boom, it is virtually a reverse indicator for when not to be bearish on commodities.

Baltic Dry Index

The shake out has been short lived and may have further to run, depending on the virus news flow. But the Chinese policy response has been swift and decisive.

That should cement the cyclical upturn going into 2021 for the newly re-elected Donald Trump. - Yah, I said it... Trump. After the debacle in Iowa, centrist leaning voters are unlikely to bother to even vote for any of the 'gang who couldn't shoot straight', thus assuring a default Trump victory or at least a Republican-held senate. That's actually equity bullish for equities. FOMO years indeed.

It is the stock market that is going viral now.

Risk Model: 2/5 - Risk Off

Copper is rising for the first day in two weeks, but the model indicator is so deeply oversold that it won't signal risk-on for some time. And we won't be privy to the AAII expectation survey until Thursday - although even a small recovery in bullishness should flip the indicator to green status. The rapid decline in the 3Mo VIX is tantalizingly close to risk-on as well. So, while the model waits for the data to catch up, the risk-off signal given last week still holds.

Override the model at your peril. The Tuesday at 11 effect works both ways, so perhaps the bounce will peter out today and a muddling market will develop.