WMA Cara Report for week ending June 8, 2018
  • June 08, 2018 12:11 am
  • by Bill Cara & Owen Williams

Living In A Bubble

 

This week saw the Russell 2000, Nasdaq-100, and Russell 1000 Growth Indexes return to all-time record highs. The S&P 500 and Dow, weighed down by the Financials, are slightly lagging the higher beta, growth indexes. The reason for the strong move in the indexes off the early May lows is… Well, we can’t find a reason. And strangely enough, the financial media has not really been able to invent a reason to explain the rally in stocks prices. If readers need an explanation for equity strength, we can lay the blame on a still strong Non-Farm Payrolls report and PMI data, coupled with a swing back to a collective mentality that politics and interest rates don’t matter. In sum, we remain in a momentum market and company fundamentals are a secondary consideration, behind that of an attractive stock price chart.

We listened to the lyrics of a pop music song this week, Chained to the Rhythm, by Katy Perry. Interestingly, this song was released in early 2017, just as equity markets were starting to go berserk. We can’t help but relate the lyrics (which admittedly have nothing to do with financial markets) to the current equity environment:

So comfortable, we’re living in a bubble, bubble
So comfortable, we cannot see the trouble, trouble
Aren’t you lonely
Up there in utopia
Where nothing will ever be enough?
Happily numb
So comfortable, we’re living in a bubble, bubble
So comfortable, we cannot see the trouble, trouble

In our opinion, there are certain segments of the U.S. equity market (notably Tech) and even broad indexes (Dow Jones) that are living in a bubble since 2017. And as in all bubbles, investors are “so comfortable” and “cannot see the trouble”. For many momentum investors, the equity market has become “utopia” and apparently “nothing will ever be enough” to burst their euphoria for momentum stocks.

This week we review numerous signs that reveal the extent of the bubble in momentum stocks. We first update several indicator charts that measure market exaggeration in markets then provide our Top 10 Hit List of bubble stock charts.

Indicator Charts

The Short Interest Ratio (SIR) divides the dollar amount of open short positions by the average daily volume for a stock. This gives the number of days it would take to cover all short positions. We find that this ratio provides an excellent contrarian sentiment indicator. When the number of days gets too low, traders have more or less given up on shorting an uptrend. This tends to be the exact moment to get short.

Below is the SIR for U.S. equities for this bull market. The exchanges update the data bi-monthly. The lowest reading since 2012 came out with the mid-February 2018 release. Obviously the relative absence of shorts at the beginning of February was the fuel for the correction. Note that 3.5 days seems to be a key level. We saw 3.5 in mid-November 2016. Indeed equities came off prior to the U.S. election. Next, we saw 3.5 at the end of January 2016, a month that capped off a -13% correction in the S&P 500. Prior to that, we saw 3.4 at the end of January 2014, a month that saw the S&P 500 fall by -6%. Readers get the idea.

We will get the end of May update next week. Certainly the SIR has fallen from 4.3 days at mid-month. As the data comes out with a lag, investors need to anticipate. If the SIR collapses under 4 days, we would look to lighten up on positive market days, as the subsequent bi-monthly reading may approach 3.5, which will likely correspond with another sell-off.

 

To get a different perspective, we took the total amount of Short Interest on the U.S. market and divided this number by the U.S. Total Market Cap. This chart is one of the best pictures of euphoria that we have seen. The all-time low for the ratio occurred on January 31, 2018 at 6.4%. The latest reading is a hair above, at 6.9%. It’s hard to believe that any investor, even the “long-term investor”, would chose to put fresh money in U.S. stocks today. However at market extremes, the crowd is always wrong and buying at moments like this is how most non-professional investors end up losing money in stocks.

 

 

We have been writing a lot about the Big 5 and several Dow stocks that have been driving index gains. Looking at the percent of S&P 500 stocks above their 200-day moving average, we can not say that the market is hitting on all cylinders. Of course anything could happen, including a sudden renewed interest in lagging stocks. But at this moment, we can speak of relatively narrow participation, which is typically a warning sign for equity rallies. This is not a “bubble” indicator, but something to keep an eye on.

 

And to conclude this week’s indicator update, our ultimate bubble chart: Margin Debt as a percent of U.S. Household Income. At 4.22% in January 2018, we would have thought that level would have taught speculators a lesson. Apparently not….

 

Our Top 10 Bubble Stocks

In this section, we post what, we believe, to be the greatest bubble stocks at the moment. Markets have not been trading off company fundamentals for a while. Look no further than stocks like Tesla. What investors and traders are looking at, naively enough, is just stock charts. Squiggly lines and chart trends. And what pays is momentum….no matter how parabolic the chart gets.

To get perspective, we posted 15-year monthly charts for each stock. Investors can do nothing with these stocks but damage their portfolio. Try to short and you’ll crack and buy in 15% higher. Go long and one day you’ll wake up and see that half your money has disappeared.

Number 10 : Tesla (TSLA)

 

Number 9 : Home Depot (HD)

 

Number 8 : Facebook (FB)

 

Number 7 : United Health Group (UNH)

 

Number 6 : Visa (V)

 

Number 5 : Apple (AAPL)

 

Number 4 : Google (GOOGL)

 

Number 3 : Boeing (BA)

 

Number 2 : Microsoft (MSFT)

 

Number 1 : Amazon (AMZN)

 


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