Yet Another Rally

It appears that the stock market is now on a three-day winning streak, as illustrated by the increase on Friday, October 9. And the stock market is on fire, as it has risen 7.4% since September 23. Some investors need to be reminded that the rally since the bottom on March 23 isn’t normal. 

A 7.4% gain would be a slightly less than the average year, and we got those gains in 2.5 weeks. The S&P 500 is only down 2.9% from its record high. Most don’t see it surpassing that high soon as the tech/cloud stocks are way overvalued.

If a stock is extremely overvalued and it falls 20%, it shouldn’t come back to new highs. It should stay below its high for years. For example, Amazon (AMZN) fell 16.3% and has since risen 11.2%. It was in a bubble in August. That peak shouldn’t be surpassed for a long time. Amazon faces antitrust legislation, more competition in the cloud from Microsoft (MSFT) and Alphabet (GOOGL), and a decline in demand growth in online shopping once the pandemic is over. The future isn’t as bright for Amazon as 2020 was.

Review Of Friday’s Action

Even though there wasn’t any economic news on Friday and the COVID-19 news was poor, the stock market still rallied on the prospect of a stimulus. The S&P 500 increased 88 basis points, the Nasdaq was up 1.39%, and the Russell 2000 was up 55 basis points. The Nasdaq 100 is now up 8.16% since the September bottom, which means it has outperformed the S&P 500. That’s not what most expected to happen. Tech stocks are way too expensive.

The Cloud index was on a rampage as it rose 2.15%, which put it up 13.83% in the past month. It’s down just 81 basis points from its record high on September 2. Shopify (SHOP) has managed to almost recover all its losses, as the stock was down 23.2%. It’s now down just 3.4%. Even with all the optimism in markets, Draftkings (DKNG) managed to fall again as the stock was down 4.5%. It has been down 23.5% in the past five days. 

The Small cap value index was flat, which is interesting because it topped at this price in June and August. Generally, technical analysts say triple tops aren’t common. Let’s see if it can break through that level this coming week. Bank stocks finally fell, as the regional bank index was down 1.1%.

Small Caps On A Run

Small cap stocks and banks have had a great month. As you can see from the chart below, the relationship between small caps and large caps has turned. Small caps have beaten large caps in the past two weeks by the highest amount since 2016. Obviously, beating large caps by 5.2% every two weeks won’t continue, but the long term trend is in the favor of small caps as the economy will enter a cyclical upturn next year.

It’s pretty clear there will be a massive fiscal stimulus. The only question is if COVID-19 can be suppressed. Testing is increasing rapidly and treatment is improving. For example, in France, the seven-day average of new cases is exploding. It’s up to 16,617. It was 10,116 on September 21. Despite that huge increase, the seven-day average of deaths is just 62.

Insane Expectations For Future Returns

Due to recency bias, people’s expectations of future returns are largely impacted by recent results. That’s why so many people are so bullish on FAANG stocks and software in general. It’s why they are bearish on banks and energy. Recency bias has gotten so extreme that people are expecting above average returns when below average returns are more likely. 

In 2018, people thought their portfolios would rise 9.9% per year. Now they expect a 10.9% rise. You should expect roughly a 6% rise if you are globally diversified. In the Americas, people expect 13.2% returns, probably because they own many American stocks which have done well.

As you can see from the table below, optimism is the highest in America, which is exactly the wrong approach. Unless you own small cap value stocks, expecting above average returns is insane. It shows how wild stocks have gotten in America compared to the rest of the world. This figure is so high because FAANG has carried US stocks.

SPAC Craziness

SPAC madness shows we are near the end of this bull cycle, not at the beginning like some may think. Investors don’t care if stocks bottomed under seven months ago. We are at the end of a market cycle which has seen excess optimism. As you can see from the chart below, there are almost 200 SPACs outstanding, which is over double the number in April. A SPAC is just a manner of raising capital.

Some investors don’t necessarily agree with calling it an asset class. However if you do, the category has a total market cap of $80 billion. It’s wild how much of an uptrend this is in despite the recent crashes in Nikola (NKLA) and Draftkings. 

That’s because more SPACs are occurring. Even if they fall, the asset class size will rise. Amazingly, the asset class was only about $25 billion in April. It barely existed. Now it’s almost mainstream.

Bad COVID-19 News

News on COVID-19 was mostly negative again on Friday. Only good news is there were 1.098 million tests, which is the fourth highest amount ever. The seven-day average is up to 959,320 which is a record high. 

Bad news is there were 57,542 new cases and 34,839 people in the hospital. We can expect the number in the hospital to rise to above 40,000 before this third wave is over. The seven-day average of cases in Wisconsin is just 34 away from the October 3 top (it’s now 2,416). 904 people died in America; the seven-day average of deaths is 694, which is pretty low, but it’s about to go up.