Tuesday, January 28, 2020

Super Bubble Damage Assessment

In a momentum bubble, fundamentals don't matter. As the bubble diverges from the underlying fundamentals (earnings, economy), only momentum technicals matter: moving averages, trendlines, and support levels. Momentum speculators place stop losses at these key support zones. It's only when momentum breaks to the downside that the diverged fundamentals begin to matter again, as broken support levels reveal the chasmic gap between price and fundamentals...

In an indexed super bubble, fundamentals are of no consideration. According to modern portfolio theory, market index funds are the most "efficient" way to invest, because the vast majority of active managers can't consistently beat the market. However, the drawback to this approach is that inbound money automatically flows to the highest market cap stocks regardless of fundamentals, which is how an index super bubble is created. Traditional value investing goes out the window. At this juncture, the five highest market cap stocks - all Tech companies - now command 18% of the S&P market cap, and 50% of the Nasdaq 100. More importantly, they command a far greater share of the recent market return. The inflows to the index artificially inflate the returns of the largest cap companies. For example, the largest cap stock Apple, doubled over the past year despite no change in the underlying fundamentals.  

These five mega stocks all report earnings over the next five trading days. Apple tonight, Microsoft and Facebook Wednesday, Amazon Thursday, Google Monday.

“A ratio like this is unprecedented, including during the tech bubble"

Where it gets far worse is the fact that investors are crowded into the most over-valued growth stocks even as the economy is slowing down. In Y2K the GDP growth rate was 5%, whereas currently it's 2% despite an asinine 10% combined fiscal and monetary stimulus (annualized). Riding into a recession in the most overowned and overvalued stocks, is a disaster.

The Y2K drawdown in Tech was -80%. In the S&P 500 it was -50%. 

Worse yet, today stock market capitalization relative to GDP is the highest in U.S. history:

Getting back to technicals, here we see the Nasdaq replaying the January 2018 melt-up implosion (VolPlosion 1.0). New highs (lower pane) reached a similar level and overbought status (RSI) similar extreme as well. Each break of the 50 dma (blue line) saw a test of the 200 dma (red line). Which happens to be another -10% below the current level.

That is the best case scenario for bulls:

Emerging Markets are already through the 50 day (blue line)

Crude oil is through the 200 day (red line) and looking similar to October 2018. The one year trendline is now broken:

Outside of Utilities, defensive recession stocks are rolling over as well:

Here we see NYSE breadth rolled over at the exact same level as January 2018:

The crash ratio is pinned to the extreme. Five stocks now holding up the casino...

The wildcard of course is the Fed who meet today and tomorrow. Now that the repo crisis has passed and the much feared end of year liquidity collapse has been avoided, I highly doubt they are in a mood to bail out casino gamblers. After all, they know that in monetizing Trump's deficit, they created this bubble.

"The Federal Reserve’s low interest rates, the perception that there is a high bar to future increases and expansion of its balance sheet are helping to lift asset prices, Federal Reserve Bank of Dallas President Robert Kaplan said.

“All three of those actions are contributing to elevated risk-asset valuations,” Kaplan told Michael McKee in an interview Wednesday on Bloomberg Television. “And I think we ought to be sensitive to that.”

In other words this belief that they will now bail out markets amid the perception that they have created a bubble, is sheer Wall Street fantasy. What someone would believe if they were not hedged. Sadly, on a long enough timeline every moron implodes. 

The bailout will surely come. After the crash.

And that will be too late for the MAGA Kingdom. Existential lying can get them into the Trump bubble, but it can't get them out.