Sometimes the correlation between markets amuses me... Today's headline in the Australian FINANCIAL REVIEW: "ASX slips as US stimulus stalls" What connection is there between an American getting $2,000 in his pocket and the ASX is beyond me.
200pt rally in the DOW in the last few minutes of the 2020 trading session wasn't a surprise, a similar movement for the S&P was seen, however, the NQ & RUSSELL were muted in comparison. If the Monday effect and the Santa rally tradition continues we might see further rises till Wednesday, thereafter, reality might kick-in. Everything good that could be priced-in has been baked in the prices, now we need to see whether the price to perfection is justified or pie-in-the-sky... will the vaccine bring everything back to normal? and will companies live-up to earning expectation in Q1? My view is that neither is true. There is no more good news pending... the vaccine is here, the Fed has telegraphed what it intends to do, the stimulus bill is passed and the results of the election are final, so, nothing more to hope for, but plenty to prove that all the optimism materializes. A 10% correction around the corner is the most probable scenario for Q1.
Considering where we came from off the lows in March - 10% is peanuts. I do think however much of the first half of 2021 will be sideways to down.
Indeed, 10% is just deflating the froth. The Buffett Indicator puts markets at 46% overpriced compared to GDP, however at this point one should not fight the Fed as according to the Buffett indicator, the Fed's intervention has distorted market pricing by 48%, but if inflation spikes or Powell screws-up as he used to do, we might well see a 20%-30% correction in Q2 or Q3 (noting that 48% of the current market price is attributed to the Fed). It all depends on the Fed while also keeping in mind that Biden is not Trump, Biden will do what needs to be done in environmental policies and taxation irrespective on whether the policy is good or bad for markets. Further, Biden will not be pressuring the Fed to keep market prices elevated.
Although the consensus of fund managers is that markets will rise in 2021, I remind all that these same experts were calling for a revisit to March lows back in April and May. They were wrong then and I think they are wrong now. I've said this before... the Fed has no tools to create demand nor to increase earnings, the Fed's action is aimed at assisting some businesses to keep going and keep their staff during the lean patch. When some normality returns, the Fed will stop flogging dead horses and so markets will then return to price stock on earnings, at that point, unemployment numbers will matter as earnings are related to the demand the employed can create i.e. high unemployment numbers will no longer be seen as good news, it will be seen for what it is... reduced demand leading to reduced earnings leading to lower stock prices.
Markets are continuing with their irrational behaviour, ignoring everything even events that previously had caused a caution. Early Jan a Democratic majority was seen as giving Biden a clear run to re-impose regulations and higher taxes, but when the majority eventuated, markets rallied. Virus infections and sadly deaths are peaking previous records and lockdowns are again being imposed, yet markets are moving up as if the economy was booming, having now well surpassed the pre-virus highs, which were even then (at a higher GDP), considered too rich. The Buffett indicator now at 190% shows the S&P at 50% above the historical average compared to GDP. Japan is even more irrational than the US markets, today a state of emergency has been declared with Tokyo in full lock-down for the next month. More-still, GDP is in contraction and the Yen is sky-high, yet today the NIKK225 broke 28k, a level not seen since the property bubble burst 20 years ago.
On simple calculations. If we were to apply current stock prices, we conclude that players are expecting 2021 markets to raise by least 24% for small caps and 13% for the S&P. Considering that we are just 10 days into the year with real unemployment close to 10m and GDP below that of 2019 but with stock prices already over the historical yearly average by 14% on Small caps and 3% on the S&P, one needs to ask just how much steam is left in the rally? and, is a correction that will align stock priced to the economy coming?
Friday will kick-off the reporting for Q4. It is to be seen if companies will give forward guidance this time as since Q2 many did not. Since May 2020, markets have been rallying mostly on NABAF, each time a company beat analyst's estimates it was bought even though the actual reported earnings were below Q1, however, the buying has been so relentless that prices for many companies can now only be justified if earnings are at least 25%, and for some 50%, above 2020 Q1.... a rather tall expectation considering the state of the real economy. Markets reached all-time highs during the traditional Santa rally but have very much flat-lined since then. Let's see what the reporting season tells us and how markets will react to some real earnings figures and hopefully some forward guidance. I am of course assuming that market players will be acting with common sense, not like they did when Musk mentioned: "Use Signal" which immediately sent a penny stock called Signal up 600% without even knowing what they were buying. Talking about Musk, he went on CNBC telling everybody that TESLA stock price is too high but I guess "too high" is not what market players want to hear, so (unlike Signal) he was ignored on that one and TESLA didn't fall.