The bar is raised on information that may elevate the market as the group now believes the subsequent 12 months will probably be good

Traders work on the trading floor of the New York Stock Exchange.


For most of the eight months since the height of the Covid crash, the stock market rebound has sparked rampant doubt, disbelief, and cognitive dissonance about resurgent asset prices facing a badly damaged economy.

No more. The Wall Street rally has now entered the belief phase, and stocks have seen a surge of belief at the end of a difficult year that better times are certainly near.

As with any collective change in sentiment, the reasons for this are obvious and clear. Aside from the S&P 500 soaring more than 60% from its March low to another record high last week, progress on most major fronts has been better than expected.

The "Economic Surprise" indexes, which measure macro data relative to forecasts, turned positive in June and stayed there for five months. Third quarter corporate earnings were better than expected for more than a decade than any other period. And two vaccine candidates with greater than 90% efficacy were far better results than the consensus predicted.

Add in a (mostly) fixed choice that investors have seen positive results, and it's like Wall Street has seen a movie called "The Subtraction of Fears" in the past few weeks.

The growing belief that the market can continue to rise has raised the risk appetite to some notable extremes.

Get used to the phrase "since January 2018" because many behavioral indicators have reached their last seen level.

The four-week global inflows into equity funds? Highest since January 2018.

Likewise, the ratio of upward and downward revisions to earnings estimates for S&P 500 companies.

The fund managers in Bank of America's latest monthly client survey had the highest portfolio allocation to stocks since January 2018.

And the week before last, the American Association of Individual Investors poll found that 55% were bullish, most of them since … well, guess what.

2018 Redux?

January 2018 was a moment when investors went all-in and celebrated the just-passed corporate tax cut that has been gradually priced in for many months. Shortly after that, I called it the "greatest fortune" moment for the bull market, and it stayed that way.

Sudden stress in the volatility instruments market then coincided with a series of trade hostilities that sparked a quick 10% correction, months of sideways trading range, a new summer high, and then a fourth quarter collapse to even seal a bad year there the economy was doing pretty well all along.

This is not a prediction of a repetition of this exact experience. As mentioned here a few weeks ago, not every rally needs to be fed by ubiquitous pessimism to move on. The early cycle recovery forces at work now are not the same as those behind the 2018 mature expansion / Fed tightening.

And the year before January 2018 was one of the strongest and most hypnotically calm in the recent past – unlike 2020, with its melting / collapse / phoenix rising pattern.

So it could be early to sound the alarm when investor beliefs turn into "overbelief" in the good things to come.

Threshold for what can stimulate the market

However, when the markets have already gotten a bunch of better than expected news and the crowd is generally assuming that the next year will be good, the threshold for market friendly developments rises and something (who knows what?) Often comes to the happy consensus, at least temporarily to question.

Last December, when the indices and sentiment seemed overwhelmed and the market continued to rise (2014, 2017, 2019), corrections of varying severity followed in the first quarter of the following year, notes the technical strategist Chris Verrone of Strategas Research .

On a practical basis, this suggests that investors continue to understand how much a cyclical recovery has already been accounted for in areas of the market and in individual stocks.

The recent expansion of the market from huge, indomitable growth stocks to smaller, lagging, less popular, and more cyclical stocks has been seen as a sign of a healthy bond with positive economic effects. And sure. But the trick will be cleared when prices get to a point where they embed a very good recovery.

Looking at the industrial sector of the S&P 500, the price / earnings ratio is well above the range of the past decade on both an absolute and relative basis. This certainly reflects the short term lower profits due to Covid disruptions and the impact on Boeing's business. Suffice it to say, it is not news to the market that global manufacturing will be on the upswing for the next year.

Or consider Walt Disney, whose shares briefly returned to their record price almost exactly a year ago last week, in a fresh flicker of optimism about his streaming video strategy.

The stock is now both a popular "stay-at-home" game in the face of subscription growth at Disney + and a central "reopening" proxy in the face of the theme park business. Great company that survives the difficult times with great brands and a solid long-term strategy for customer loyalty.

Given its share price and quite high levels of debt, the company is still at a record multiple between company value and cash flow at today's price, even if Disney cash flow is about to hit its 2018 high (a huge if). Now, if the market is happy to be assigning Netflix-type multiples to Disney streaming subscribers in order to make historical valuation parameters irrelevant, then as a buyer you should be aware that this is implicitly your own bet.

Again, this is not an indictment of this rally as being irrational or doomed. The market was impressively resilient, switching between groups in a way that is refreshing, confirmed by global equity strength, aided by impressively strong credit markets, and fueled by seasonal tailwinds that are difficult to combat.

Most relevant leading indicators, based on recent market breadth and cyclical trends, point to attractive returns for six months or more, but less so in the short term.

A bull market can be like Tinkerbell, which is brought to life by the applause of the audience alone and illuminated for an indefinite period of time. If only there was a way to know when the crowd is getting tired of clapping.

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