Dalton — I grew up (if you want to call it that) with Mad Magazine. Alfred E. Neuman was the fictitious cover boy of Mad. Interestingly, Alfred’s image was created before Mad, appearing in early 20th-century advertisements for painless dentistry. It was in the dentistry advertisements that we first learned of Alfred’s motto, “What? Me worry?” A Mad cartoonist named Harvey Kurtzman spotted the ad and pitched using it as the magazine’s mascot, saying that “it was a face that didn’t have a care in the world.”
I, Allen Harris, hereby nominate Alfred E. Neuman to be the face of the U.S. stock market as the calendar flips from 2020 to 2021.
The stock market, as they say, likes to climb a “wall of worry.” Investors, however, don’t seem to have a care in the world.
The stock market has priced in another round of effective fiscal stimulus. It’s priced in a broadly distributed vaccine. It’s priced in government elections not being a roadblock to corporate progress. A significant economic rebound for the second half of 2021 is baked into the market. The stock market is priced to perfection. That leaves it vulnerable to bad news.
But maybe we don’t get any bad news. What if everything that is priced in, happens? Then what? What is that next catalyst that will move the markets much higher? What is the worry that remains which can be solved to help give the stock market another boost? I want stock prices to go higher, but I would feel better about it if they were doing so on the back of solidly improving fundamentals.
The only thing that seems to be lifting the stock market higher recently has been irrational exuberance. The good news there is, that can be enough. On December 5, 1996, then-Federal Reserve Chairman Alan Greenspan said that “irrational exuberance has unduly escalated asset values.” Asset values continued to rise, with some interruptions, for another three years.
There’s a lot of optimism in the stock market today. I’d dare some of it is irrational. Investors are buying some stocks just because they see them going up in price. Those investors don’t know why they are going up. They just expect it to continue, though they have no educated insight as to why it would do so. Bitcoin is an excellent example of that.
I don’t fault people for trading Bitcoin, or trading anything. Go for it. However, there’s not an “investing” reason why investors are buying Bitcoin.
Bitcoin is a solution in search of a problem. It has no intrinsic value — it’s only worth what someone else will pay for it. Owners of Bitcoin are cult-like. They create some misinformed narrative about why they should own some percentage of it in their portfolio. They opine that it’s going to be a necessary storage of value in the future, thus it should be worth something someday.
People can try to rationalize whatever they want. Neither a hypothesis nor hope is a fact. So why is Bitcoin’s price on a tear? It’s an asset with limited supply. Bitcoin has lots of dollars chasing it because the owners of those dollars have convinced themselves that there is some reason why it should be worth more than it is. Despite no logical reason that Bitcoin should be worth more. The stories attempting to rationalize why are ridiculous. Bitcoin traders have convinced themselves that a good trade has become a good investment.
There doesn’t seem to be a worry in the world about Bitcoin finding some utility and, at some point, deserving the value it currently trades at. The prices of many stocks are going up because of a similar irrational level of exuberance by investors.
That’s not the first time this has happened. Heck, back in January 2020, I was observing similar things. We’re not yet at that level of over-optimism for U.S. stocks, but it’s not as if we’re miles away. A countertrend downward move in equities may develop due to economic disappointments over the next three to four months. For the next few months, the U.S. economy will have to further contend with rising COVID-19 infections and the resultant social-distancing measures.
Investors will feel the sting of a correction from these levels. Still, it’ll just be a correction. If this happens, my plan is to consider selling large-caps and buying small-caps with the proceeds.
If the stock market goes up another ten percent before it goes down ten percent, I may want to proactively take some chips off the table to get a bit more defensive. Currently, I’d expect any defensive measures to be reasonably small. I expect the expected to occur. The expected is a lot of good news: stimulus, vaccines, economic rebound. The U.S. economy is off its best levels, but the fundamentals look to be trending toward improvement six to 12 months from today. Supporting the fundamentals are some improving technical indicators.
The weight of the evidence supports an increasingly healthy, long-term advance. For example, one of the harbingers of coming and enduring stock market weakness is that small-cap stocks begin to falter. The advance-decline line is a measure of how many stocks are participating in a rise or fall. It is an affirmation of the broader market’s advance if more stocks are participating in the rally. When the advance-decline line of stocks in small-cap indices begins to falter, that reflects weakening internal conditions. The advance-decline line will turn down weeks or, more often, months ahead of consequential market highs.
In the last decade alone, the small-cap advance-decline line forewarned of essential turning points. The line turned down in April 2011, April 2015, August 2018, and January 2020. Not that the advance-decline line predicted the 2020 pandemic; for months prior, I argued that there was the likelihood of a 2020 recession even sans-pandemic. The stock market had begun to price in that prediction.
The advance-decline line for small-caps, I suspect, will continue to serve as the proverbial “canary in a coal mine” for the broader market. The canary is healthy. Consider the number of small-cap stocks either 20 or 30 percent below their 52-week highs. Last week, both of those indicators recorded their lowest readings since September and October 2018, respectively. That is good news for bulls. These advance-decline line indicators are especially impressive given that the market is still within 52 weeks of its March 23, 2020 bottom. The recent new lows of these indicators are evidence of an advance that is broadening as it ascends.
That does not rule out those all-too-frequent five to 15 percent corrections. But it’s good to be aware of the fundamentals and the technicals. If the market dips by double digits, knowing this information will allow me to stick to my plan. It will remind me to be more tactical and less emotional in response to the decline.
This article originally appeared in The Berkshire Edge on December 28, 2020.