Strategy: From FOMO to LIFO.
The current bull market has been plagued by panic attacks. That’s not surprising given how traumatic the preceding bear market from October 9, 2007 through March 9, 2009 was, with the S&P 500 dropping 56.8%. Ever since then, it hasn’t taken much to scare the living daylights out of investors, particularly those with a pessimistic streak. In other words, investors are still suffering from PTSD resulting from the previous bear market.
Joe and I have been keeping track of the current bull market’s panic attacks in S&P 500 Panic Attacks Since 2009
. By our count, there have been 60 of them including the latest one. Four of them were associated with outright corrections, defined as a 10%-20% drop in the S&P 500 (Fig. 1
). There have been plenty of mini-corrections, defined as 5%-10% declines.
In addition to those corrections, Joe and I count any minor selloff that was associated with a panic-provoking event. So, for example, we count the two-day Brexit selloff (down 5.3%) during June 2016 as a panic attack. The Fed was a source of angst a few times. There was a “tapering tantrum” during May 2013. There was a Fed tightening tantrum in early 2016 and again during September of that year (Fig. 2
). All together, we counted seven panic attacks in 2016. There were only two last year.
This year started with a 7.5% meltup during January that set the stage for a fast 6.1% reversal during Friday and Monday, again mostly on Fed tightening concerns. Consider the following related observations about the current selloff:
(1) Flow of funds
. From a flow-of-funds perspective, Joe and I have noted that over the past year, equity ETFs saw record inflows. This development suggested that the bull market was starting to attract buyers motivated by FOMO, i.e., fear of missing out. In recent days, many of them seem to have concluded that they managed to get in right at the top. So they made a
top (not necessarily the
top) by panicking out of their recently acquired stock holdings. Instead of a FOMO-led meltup, we may suddenly have a meltdown driven by LIFO, i.e., last in first out.
(2) The Fed & inflation
. The stock market may be a market of stocks, but it also occasionally has a collective agenda to force new Fed chairs to pay respect. The market did that to Fed Chairman Alan Greenspan in October 1987 with a meltdown that caused the new Fed head to introduce the Greenspan Put. Was it a coincidence that the stock market plunged on Friday as Fed Chair Janet Yellen was leaving the building in that role for the last time, to be replaced by Jerome Powell on Monday?
The higher-than-expected 2.9% increase in wages in Friday’s employment report might not have upset stock traders at all if Yellen had remained in charge. That’s because she would have said that while 2.9% is welcome, she wants to see 3.0%-4.0%. Left to his own devices, Powell probably would have said the same, and stressed that Yellen’s policy of gradually monetary normalization will be maintained. However, the market’s selloff may be the market’s way of forcing the new chairman to declare his allegiance and show he is willing to provide a Powell Put if necessary.
(3) Bond yields
. Of course, the issue for the stock market this time isn’t earnings over the foreseeable future, but rather inflation and interest rates. Our view is that inflation is likely to remain subdued around 2.0%. Bond yields, on the other hand, may be normalizing around the world as the major central banks ease off on easing off. That’s a good thing because it confirms that the global economy has achieved self-sustaining growth and no longer requires propping up by the central banks.
It no longer makes much, if any, sense for Germany’s 10-year government bond yield to be below 1.00%, as it has been since late September 2014 (Fig. 3
). Neither does it make much sense that Japan’s government bond yield remains near zero (Fig. 4
). From this perspective, the US Treasury bond yield at 2.80% certainly is already a lot more normal than comparable yields overseas.
If the Fed proceeds with three rate hikes this year, as widely expected, that will push the top of the federal funds rate target range from 1.50% to 2.25%. The US bond yield could rise to 3.00%-3.50% in that scenario. The bull market in stocks could certainly resume in that environment, especially if the higher interest rates confirm that solid economic growth is boosting earnings.
(4) Another panic attack
. The bottom line is that Joe and I view the latest selloff as Panic Attack #60 rather than the beginning of a bear market. We can’t rule out a 1987-like event, which amounted to a one-day bear market. Back then, it was portfolio insurance that caused stocks to plunge on Black Monday, October 19. So far this time around, we have Blue Friday followed by Black Monday. There’s no evidence of an ETF flash crash so far, which—if it happens—might accelerate the selloff much as portfolio insurance did in 1987. While investors have suffered a black-and-blue bruising, we believe that the underlying strength in the global economy combined with the Trump tax cuts will boost earnings significantly this year.
Valuation: Too Late To Panic?
In the stock market, panic attacks occur when investors fret that valuation multiples are too high because a recession suddenly seems more likely and even imminent, or because an upside inflation surprise raises the risk that the Fed will be forced to raise rates, which raises the risk of a recession. Panic attacks occur when the market’s P/E takes a dive on these concerns, but the rout is abated by continued gains in earnings. The bull market resumes as recession fears abate.
While industry analysts have been scrambling to raise their earnings forecasts in the weeks following passage of the tax cut at the end of last year, investors decided to throw a tantrum on Friday and Monday that caused the forward P/Es of the S&P 500 to drop 6.1% from 18.0 on Thursday of last week to a 13-month low of 16.9 on Monday this week (Fig. 5
). Over this same period, the forward P/Es for the S&P 400 and 600 dropped 5.5% to a 15-month low of 16.8 and 5.7% to a 15-month low of 18.1, respectively.
As we’ve been noting in recent weeks, our Blue Angels analysis shows that forward earnings are soaring for the S&P 500/400/600 into record-high territory (Fig. 6
). Bear markets don’t happen when earnings expectations are going up for perfectly good reasons.
The last correction lasted 100 days and took the S&P 500 down by 13.3%. It occurred from November 3, 2015 through February 11, 2016. In our 1/25/16 Morning Briefing
, we wrote, “Joe and I believe that it may be too late to panic and that Wednesday’s action might have made capitulation lows in both the stock and oil markets.” The S&P 500 bottomed on 1829.08 back then. At the risk of pushing our luck, we’ll try it again: “It may be too late to panic.” (BTW: In that same piece, I reported that I stayed in Room 666 at the Radisson Blu Hotel in Zurich, which I viewed as another reason to be bullish since that number helped me to get bullish in March 2009. On Monday of this week, the DJIA fell 666.)
Dr. Ed Yardeni
is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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