Is This Still A Bear Market?

“Are equities still in a bear market rally?”, BNP asks, on your behalf, in a note dated Friday.

It’s a question worth asking. I often adopt a somewhat fatalistic cadence when making the case that beyond a certain point, normative debates about what “should” be happening or what will eventually happen “if there’s any justice in world” are irrelevant when it comes to assessing the state of affairs in the here and now.

For example, back when Bitcoin was at ~$20,000, it made little difference to anyone who bought it at $5,000 (let alone anyone who got in when the mania was in its infancy) whether it has a date with zero in the longer-run (which it almost assuredly does). As long as you locked in some gains, it was a great trade.

The same is true of equities’ surge off the March COVID-panic lows. Regardless of what’s driving the rally, and irrespective of whether it makes any “sense” (which it actually does when you consider Fed liquidity and the fact that stocks “pull forward” future outcomes), the Nasdaq 100 is now less than 2% from its closing highs in February.

Anyone predicting a retest of the lows (e.g., Jeff Gundlach) was wrong. They may well be “right” later, in which case they’ll invariably claim to have “nailed it”, but nobody with any sense would call that “right”, considering that had you bought big-cap tech in late March, you’d be up nearly 40%.

For new readers, note that this isn’t coming from someone who is by nature a bullish individual. I lean (sometimes heavily) bearish/skeptical, but that doesn’t stop me from stating the obvious in the teeth of a rally.

Even if it falls apart first thing Monday morning, this is already on the books for those who were smart enough to play the bounce and take some chips back off the table.

Some folks I’ve spoken to over the past week, for example, were convinced that the March plunge was more “growth scare” than existential crisis. Even if it was an existential crisis, one equities strategist remarked, the same tech names which were buoyant before, would be buoyant again simply by virtue of benefitting from changing consumer preferences, work arrangements and attitudes towards social interaction, in a post-COVID world. She didn’t say as much at the time, in part because that wasn’t a politically correct thing to say in the midst of a pandemic, but here we are two months on and the two-month rate of change for the Nasdaq 100 is among the most spectacular in history.

It just is what it is, folks. And it may not be what it is today, tomorrow. Especially considering spiraling domestic turmoil in the US on top of worsening Sino-US relations.

But as BNP writes in the same note mentioned above, “so far, in the struggle between weak, uncertain fundamentals, on the one hand, and huge central bank-fueled liquidity impulse, on the other, liquidity appears to be dominating”.

Spoiler alert: Liquidity usually does dominate, even if, as BNP goes on to point out, “sentiment surveys and institutional investor flows point to [a bear market rally] remaining the consensus view, with little evidence of institutional investor participation in this latest leg of the rally”.

The figure below is Goldman’s sentiment indicator which rolls up retail, institutional and foreign investor positioning versus the last 12 months.

(Goldman)

Market participants are still skeptical. And that’s totally justified, for reasons I don’t have to recap here in their entirety.

BNP touches on a few quick points. “We still see scope for equity markets to drift lower over the summer, as the extent of the damage to corporate earnings and balance sheets becomes clearer”, the bank says, adding that “seasonality is also a good reason for caution in the short term after such a powerful recovery rally, with August and September particularly prone to market falls”.

Combine that with domestic social unrest and geopolitical tension, and you end up thinking it might not be a bad idea to hedge.

And then there’s valuations, which are high, to put it mildly. They’ll be stratospheric in the event earnings expectations fall further.

But does that matter? Well, it depends on one’s horizon.

“Bearish investors would (correctly) point out that future returns are highly influenced by starting valuations, with higher P/Es leading to weaker performance, as multiples de-rate toward long-term averages”, Credit Suisse’s Jonathan Golub wrote, in a note dated Thursday.

(Credit Suisse)

As you can see in the right pane, it matters little over the short-term, though. Golub has long made the case that companies with healthy cash flow will trade at higher and higher multiples in a low-volatility world, as growth stocks become synonymous with min. vol. and the duration trade.

But, in the same Thursday note, he strikes a somewhat cautious tone, which is understandable under the circumstances. “Previously-skeptical investors are increasingly becoming comfortable with higher multiples”, he said. “We remain unconvinced given the current backdrop”.