Technically Speaking: Is The Narrative All “Priced In?”

Is the narrative all “priced in?”

As discussed over the past couple of weeks, investors have gone “all in.” With the markets now extremely extended, what should investors do now?

On Saturday, I discussed the risks as we head into distribution season.

“Given the ongoing extremes of the market, the imbalances suggest a more cautious approach to portfolios currently. As such, we continued reducing our equity exposure, adjusting our bond holdings, and raising our cash levels.

As shown below, with fund managers carrying some of the lowest cash balances on record, we could see selling pressure to make distributions.”

Is Narrative Priced In, Technically Speaking: Is The Narrative All “Priced In?”

However, while we may undoubtedly experience a pick up in volatility short-term due to distributions, longer-term the markets tend to be “forward-looking”. In theory, the markets are a “discounting mechanism” and start to adjust for expected outcomes.

Overly Optimistic

In this case, the market should be “pricing in” a recovery in economic growth and earnings as a “vaccine” begins to reduce the drag caused by the pandemic. However, with markets at all-time highs, investors have priced in “perfection,” leaving room for “disappointment.” 

For example, in Q4-2019, the S&P 500 finished the year at 3230.78, up 27.6% for the year. The basis of the rally was a trade deal (which never occurred,) tax cuts and massive levels of share buybacks. At that time, analysts estimated that reported earnings for the fiscal year 2020 would be roughly $167/share. Investors justified paying 19.35x earnings due to low-interest rates and expected strong economic growth.

Unfortunately, that didn’t occur. Instead, the economy got hit by a pandemic, a recession, and surging levels of unemployment. Nonetheless, due to massive government interventions, the market recovered to trading near all-time highs, up more than 11% for the year.

However, earnings for 2020 will not come in at $167/share, but rather closer to $93/share. Such is more than $74 lower than estimated, leaving investors holding assets that have doubled in valuation from 19x to 38x earnings.

Is Narrative Priced In, Technically Speaking: Is The Narrative All “Priced In?”

Investors are currently rushing into already overvalued assets once again based on expectations that 2021 earnings will rise to $143.09/share. The problem is that while investors chased the market higher, 2021 estimates collapsed by roughly $30/share. 

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Lorenzo Marinelli 1 month ago Member's comment

WOW! A coherent and data-sourced perspective that doesn't have BS nonsense from a permabull or permabear perspective. Very refreshing!

When the market does cool-off or worse, it will of course be more exaggerated because of the silly, binary narrative of (nearly all) media and newbie investors with small accounts: This market only goes up, the market is forward looking, valuations don't matter because it's market-priced...

History tells us that markets always revert to sanity. We should learn to enjoy the ride up, while expecting the floor to drop the higher we get. It's always far more profitable to miss out on some upside to protect from a larger downside.

Terrence Howard 1 month ago Member's comment

Well said.