Happy Anniversary, Tech Bubble
This Friday, March 24th , marks the seventeenth anniversary of the Tech Bubble peak. Markets tend to be fond of historical dates and other milestones. We remind readers, who falsely are assuming that the market top won’t occur until this summer, that the first quarter has also seen some significant market tops in U.S. equities (1937, 1962, 1966, 1969, 1973).
We recently looked at past bubbles in our March 3rd Commentary. To celebrate the anniversary of the Tech Bubble, in this missive we compare what happened in tech stocks in 1999/2000 versus today. Our weekly chart of the Nasdaq-100 below shows how the tech bubble played out. In 1999/2000 we saw several months of vertical (or parabolic) price rise followed by a first down-draft (-35%), a tradable bounce, and then the final wipe-out (-80%). While today’s price rise on the Nasdaq-100 is not nearly at parabolic as in 1999/2000, we don’t believe that conditions today will foster a bubble of the same proportions in the Nasdaq. Valuations, while not yet at 2000 peaks, are at the second highest level since the inception of the Nasdaq in 1985. It is unlikely that seventeen years will erase the stinging lessons that many investors learned during the tech bubble. While there are many younger investors and traders who did not suffer through the tech bubble, we can not imagine that the post-tech bubble generation will be capable of reproducing the full parabolic rise we saw seventeen years ago.
We remind readers that the top of the tech bubble in March 2000 occurred for no apparent reason. Simply buying exhaustion, which may be what we are facing again today. Those looking for the smoking gun to warn them that it’s time to sell tech stocks will relive the errors of investors in 2000-2002.
What makes today’s Central Bankers’ Bubble different is that many sectors and indexes are also in bubble territory. Take a look at the S&P 500 Consumer Staples Index below, for example. You’d have be drinking some pretty strong Kool-Aid not recognize that something is just not right here.
A note on European equities
We are hearing institutional investors in France and Europe talking up a possible massive inflow into European equities once the 2017 European elections have past. Notably, the French election on May 7 is supposedly a big hurdle to get past, as the anti-European candidate Marine Le Pen is polling very well. Undoubtedly many bank clients are hearing this narrative and looking forward to dumping new cash into European equities in May….if all goes well with the French election. Hear our warning now on European equities and save your portfolio a huge drawdown. The European equity trade will NOT play out as bank strategists are scripting in their current strategy pieces. Once the European elections are past, the election “risks” are also resolved. As any finance student knows, the expected return on any investment is proportional to its risk. A risky investment (a biotech start-up, for example) offers high expected returns and a low-risk investment (3-month U.S. T-Bill) offers low expected returns. Waiting to buy European equities once the risks have past is absurd. Savvy institutional investors are loading the trailer with European equities, which have lagged their U.S. counterparts. You can be sure that after the election, once everyone is comfortable getting into European equities, that the upside movement will stagnate and these institutions buying today won’t be holding on to their equity positions for a measly 2% dividend. The only direction will be down.
Our DGR Strategy moved heavily into European equities in March (almost 30% of our equity exposure). We expect the French election to unfold without drama, after which we will be cashing out of European equity positions.
In the next few weeks, the main risk to European equities would be if U.S. equity markets fall out of bed. Barring any major turbulence on the NYSE, we expect European equities to continue grinding higher through May.
A note on U.S. equities
We have been hearing lots of talk about a U.S. equity correction since last December (and even prior, with the “bearish billionaires”). Lots of signs point to a sharp correction in U.S. equities: excessive valuations, seemingly ridiculous speculation on the “Trump miracle”, company insiders buying stock at the slowest pace in 29 years, numerous market indicators hitting extremes (see our March 10 Commentary), and a creepy sense of complacency hanging over markets, with a VIX which has held below 15 for nearly five months now (a record for the current bull market). The fact that the Dow is only now showing signs of rolling over — – after five months of confounding pundits — shows once again that markets do whatever it takes to prove the majority wrong.
We predict that the consensus -4% to -7% correction that most investors are looking for will not occur. Who does not want to pick up more equities on the next dip? Does any savvy investor really think that this equity train is going to gently back up, let on all the latecomers and fund managers holding too much cash, then continue on its merry way, posting record highs again each day and enriching all happy investors. NOT GOING TO HAPPEN. When the U.S. equity market starts coming down for real, dip buyers will buy (as they are accustomed to do) then be forced to sell much lower. Indeed, capitulation of dip buyers may supercharge the next down cycle.
We have closed out all our U.S. equity positions in our DGR Strategy and will not be moving back in before a major correction which brings valuations back down towards fair value (1700 on the S&P 500 or there abouts). Markets are massively under-pricing risk in U.S. equities, as the “blue sky” scenario is being bought into by a growing consensus of investors. As mentioned above, if you invest in a security which the market is pricing as “low-risk”, your expected return will also be low. Most of our former U.S. equity exposure has been shifted into emerging market equities, which offer a far better return/risk ratio over the long-term relative to U.S. equities.
Conclusion
We won’t be so bold as to predict the final top to this crazy bull market here. However we will assert that the low hanging fruit (U.S. large cap stocks) has been picked and that making money in crowded U.S. stocks will be much more tedious going forward. We are far from negative on equities in general, but believe that the passive/index investing craze has over-inflated companies in popular benchmarks like the S&P 500. In our DGR Strategy we have sold definitively all our U.S. equity positions. European and emerging equities have much more upside potential and more reasonable valuations. These regions also do not have a central bank embarking on a monetary policy tightening cycle nor do equity prices in these regions reflect speculation that a new president will perform never-before-seen miracles for their economies.
Today’s U.S. equity market should be left to traders, who have been sending equity indexes into meaningless gyrations since the end of February. If you have an inclination to trade this market, be sure to accompany all your orders with a take-profit order and a stop-loss order. As the market rises, you’ll believe even more in the rally while you will not believe in any pull-back in equities. Hypnotized investors will not move to take profits quickly on a move up and will get destroyed when the real correction finally arrives.
