What a Difference a Year Makes

The relentless year-end rally continues. 2019 is tracking towards the best year for stocks in over two decades, back in those dotcom days. It’s really been a parabolic move since October, with reckless abandon. Before that, the Stock Market had been in a very defined range and had not made any forward progress since the highs reached in January 2018. And who could forget the Market crash that ended last year? What a difference a year makes. The one similarity is the extremes. Last year was an extreme sell-off. This year has been an extreme rally. This Bull Market has run over anything and everything in its way, defying an inverted yield curve, impeachment, Brexit, European recessions, oil shocks and geopolitical threats. Impressive is an understatement.

The S&P crossed over 3200 and the DOW leaped 28K for the first time ever. The Tech-heavy Nasdaq cleared 9K putting it also in uncharted waters. Apple is up 8% in December and has nearly doubled in 2019. Amazon, which has been a relative laggard this year, was up 5% just this week alone. Energy has come to life of late, becoming the best performing sector on the month, followed by Tech and Health Care. It’s been quite impressive. It’s also become a little ridiculous and begs the question, what will January bring? The Santa Rally definitely came and selling likely got pushed out to 2020, opting for the new tax year. Things are way overbought on a short-term basis. But for now, it’s a mad dash for stocks.

The American Consumer keeps flexing its muscles and opening its wallet. That is significant because consumer spending accounts for 70% of the US Economy. Americans keep shopping, particularly online, with increased frequency. US retail sales rose 3.4% this holiday season from last year driven by eCommerce. Online sales grew nearly 20% this year, and represented roughly 15% of the total retail sales between November 1 and Christmas Eve. Amazon said this was its best holiday season ever. That seems to be an annual theme for the retail giant, which all but designed the eCommerce model.

Interestingly, interest rates have stalled and are sliding back down. The 10-Year Treasury yield has remained below the key 2% level, which has acted like a glass ceiling for rates. Money is flowing back into the Bond Market. This is an issue that simply cannot be ignored. The super-strong stock rally has had very little impact on yields and bonds. Bonds have had a good year too. Historically, the stock/bond relationship has been inverse. The strength in bonds sort of contradicts the stock move.

Remember over the Summer when the yield curve inverted? That event has long signaled economic stress and high likelihood of pending recession. The Fed responded to the inverted yield curve in a big way. It aggressively cut interest rates, taking the front end of the curve lower, and steepening it to a healthier level. The Bond Market had been forcing its hand for months. So had the President. It didn’t stop there. The Fed next started injecting hundreds of billions of Dollars into the “repo” market to prevent system failures. These are repurchase agreements at the overnight rate which provide the lubrication for the financial system to run smoothly. It should be automatic. It wasn’t. The repo market nearly seized in September. It has since been called a “technical malfunction.” Part of it can be explained by excessive regulations in response to the financial crisis. That is sensible. But our question continues to be, if there is a liquidity issue which can shock the system during really good times, what happens during bad times? The question has yet to be answered. And the Fed is adamant that its actions are not quantitative easing, even though it looks and feels like it is. So “non-QE” capital injections came in October. The Fed expanded its balance sheet back to crisis levels. The Stock Market ripped higher. Asset prices inflated. They basically poured more fuel on the Bull Market fire.

There’s nothing like price to change sentiment. Rallies always generate excitement. Investor sentiment just tallied the largest number of Bulls this year. In fact, the percent of bullishness has doubled since the first week of October. It is now in the 96th percentile of the past year’s reading. We’re seeing some excesses throughout the Market right now as stocks continue to rally with the absence of strong fundamental growth. There is an extreme reading in the Put/Call ratio that is historically consistent with a correction. A low Put/Call ratio is a contrarian negative signal because it indicates extreme complacency and a lack of fear. There are far more call buyers than put buyers right now, meaning the vast majority of investors no longer fear a sell-off. That usually takes place at a Market top. Conversely, a high Put/Call ratio suggests extreme fear which generally comes at a Market bottom. That was the case a year ago with the “Christmas Massacre” which completed the 20% decline from September to year-end. The last time the Put/Call ratio was this low was December of 2017, just before the 10% correction to start 2018.

Seasonality tends to prop stocks up at the end of the year, as December is historically the strongest month for stocks. With less than a week left in the year and as bullish seasonality winds down, elevated sentiment measures and overbought conditions should begin to have more of an effect. We’ll be on guard as we enter the new year for what very well could bring another correction. There are many similarities to today and 20 years ago, during the dotcom days. Just like back then, it has not paid to manage risk and have a defensive portfolio positioning… until it does.

As Market chasers get shaken out and extreme sentiment measures and overbought conditions subside, we will be ready to buy weakness. Investing is like a marathon. There are times to speed it up and times to slow it down. Managing through challenges and having a keen awareness of your surroundings is critical to success. We don’t anticipate anything close to what happened after the dotcom bubble burst. The similarities from then and now are so far from exact. We do think a more manageable sell-off could be around the corner, to clear out the excesses and provide some mean reversion. We are locked in for year-end and are ready for a fast move in 2020.

Have a nice weekend. We’ll be back, dark and early on Monday.

Happy New Year!


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