Bulls Project Air Of Invincibility; For Contrarians, Sustainability Big Question Mark

There is an air of invincibility among equity bulls. A contrarian-minded investor may find this uncomfortably lopsided, but nothing says it cannot continue in a seasonally favorable period. The recent jump in investor sentiment is yet to translate into consumer sentiment, which in due course will have bearing on spending. This eventually can reverberate through corporate earnings.

Major US equity indices continue their upward momentum. Small-caps continue to go parabolic, while large-caps are still trudging higher. The former group is outperforming in the wake of the November 3rd presidential election and particularly after positive vaccine news from Pfizer (PFE) (November 9) and Moderna (MRNA) (November 16).

Small-caps are more domestically focused than their larger-cap peers which also have international exposure, hence benefit more the sooner the US economy gets back to normal. Investors are betting this happens next year and are gravitating toward small-caps. This has acted as a self-fulfilling prophecy in that it then attracts more investors who treat the small-cap action as a signal.

Consequently, the Russell 2000 (IWM) last Friday was 29.7 percent away from its 200-day moving average. This is the widest gap in the small cap index’s 33-year history since March 9, 2000 when a record 30.4-percent gap had opened up (Chart 1). The Russell 2000 peaked a day later back then and went on to lose 28 percent in the next five weeks, and 47 percent by the time it bottomed in October 2002.

It is obviously too soon to say if a similar fate awaits these bulls. This much we know. Other metrics show a similar buildup in optimism.

In the options market, investor fascination with calls has gone through the roof. It is important to point out that these call buyers have so far been on the right side of trade as equity indices continue to hit new highs. Once again, this acts as a self-fulling prophecy.

Last week alone, the CBOE equity-only put-to-call ratio produced readings in the 0.30s in three sessions, and in the 0.40s in two. The 21-day average dropped to 0.428 on Friday – a new low (Chart 2).

1 2 3
View single page >> |
How did you like this article? Let us know so we can better customize your reading experience. Users' ratings are only visible to themselves.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.