More than a few analysts and investors have identified what they believe is a parallel of sorts between equities perched at record highs headed into 2021 and the market melt-up that transpired in early 2018 following the Trump tax cuts.
The comparison isn’t perfect, but I suppose it doesn’t have to be. After all, we’re just spinning narratives and if you like old adages, history doesn’t repeat, it just “rhymes.”
All four major US benchmarks hit records on the same day last week, prompting more comparisons with the post-tax cut euphoria. The last time that happened was in January of 2018.
Read more: Benchmarks & The 2018 Melt-Up Parallel
Of course, the early 2018 melt-up ended in tears, when the short vol bubble burst in dramatic fashion during the week of February 5. Later, in the fourth quarter of that year, Jerome Powell accidentally tipped equities into a serious correction when over-tightening from the Fed collided with Trump’s trade war and, in December of 2018, the government shutdown boondoggle.
“Similar to the end of 2017/beginning of 2018, there appears to be a clear consensus currently in terms of year-ahead trading themes,” JPMorgan’s Nikolaos Panigirtzoglou said, in a note documenting the same “melt-up” parallel.
“In fact, the consensus trading themes at the time regarding the 2018 outlook were very similar to the current consensus themes,” he went on to say, before rather dryly noting that “unfortunately, the consensus view rarely plays out in its entirety as 2018 reminds us.”
I’d be remiss not to acknowledge that 2020 was also a “reminder” of just how awry the “best-laid plans” can go.
Panigirtzoglou said that in client conversations, one clear consensus view is a bullish take on equities. He proceeded to “assess the crowdedness” of the long equities position, identifying what he somewhat euphemistically described as “pockets of position overextension” in the near-term.
On of those “pockets” is momentum traders, who, based on the average of JPMorgan’s short- and long- lookback windows, are “very long.”
“Most of them are close to the 1.5 stdevs threshold we typically associate with a high risk of mean reversion flows kicking in,” Panigirtzoglou wrote, before assessing that on balance (and there’s a pun in there), multi-asset investors are also “rather” Overweight stocks, which “creat[es] the risk of negative rebalancing flows into year end.”
On a medium-term horizon, JPMorgan doesn’t necessarily think the long equities trade is in egregiously over its skis.
Panigirtzoglou cites a model familiar to those who follow his work. He calls it the “most holistic” measure of equity exposure. It takes into account global non-bank investors’ holdings of bonds, equities, and cash (M2), and it still suggests stock allocations are well below cycle highs.
“Although this indicator has been rising in recent weeks, it currently stands just above the post Lehman average of 42.3%,” Panigirtzoglou went on to say.
For reference, it rose as high as 48% at the beginning of 2018.
Ultimately, Panigirtzoglou’s assessment is that based on the bank’s most comprehensive positioning metric (figure above), “any equity correction in the near term would represent a buying opportunity as we are only in the middle of the current bull market.”
It’s easy to roll out the “what could go wrong?” sarcastic punchlines, but I suppose it’s worth noting that both of 2018’s corrections (in February and in Q4) ended up being spectacular buying opportunities. And it goes without saying that 2020’s pandemic plunge was, in hindsight, one of the most “buyable” dips in history.
There is a flaw in the JPM equity positioning indicator which needs to be mentioned. It does not account for the fact that overtime there is a demographic trend toward holding fewer equities due to baby boomer retirements. If you look inside that cohort the key age is 70, that is when it is optimal to take you social security discernments and to liquidate or scale down the asset holdings to less risk seeking ones. Admittedly there is some evidence that this is happening in a much slower way than it prudent, but it still helps to explain the graph.
Vlad, you wrote ” If you look inside that cohort the key age is 70, that is when it is optimal to take you social security discernments and to liquidate or scale down the asset holdings to less risk seeking ones.” I will be there (age 70) in 2-3 years and I plan to wait until age 70 to take social security. I plan for social security to cover all of my expenses. In this case and considering that my timeline is “infinite” (i.e. my kids and grandkids will get my funds, equities and properties), why would I consider “less risky” assets which provide almost no return? An equity crash would be great but the current appreciation is also “appreciated.”
If SS will cover all your expenses, then you are set and in an enviable position.
What was your thought process for how you planned on the estimate for how long you will live, what inflation will be over this time, what changes in tax policy might occur over this time, and health care costs you would reasonably expect to have to incur?
One answer I’ve given to these questions is a bottle of Makers Mark, a bottle of Valium, a beach chair, and the outgoing tide.
One of the most repeated phrases justifying the melt up that led to the February 2018 melt down was “synchronized global recovery.” You can hear that same mantra daily on CNBC or Bloomberg, and although that should give anyone pause I do believe it is more accurate this time. We can certainly have a correction in the near future, may be one as painful as the Volpocalipse, but I believe the narrative of a global recovery makes more sense now than it did back in 2018. Parts of the “globe” such as Asia are clearly recovering already, the dollar is weaker, the Fed is loose and tariff man is on the way out, it might be a global recovery that features less US and more EM but several leading indicators point towards an acceleration of growth in the near term, a successful distribution of Covid vaccines would only strengthen this impulse.
runamok: My computer objected to a Cross-site Scripting risk when I tried to post my original reply earlier today. My thought about your “one answer” is to suggest that you have floats on your beach chair so you can drift out to sea with the outgoing tide as you drift off. Your answer certainly sounds better than spending years or decades in a nursing home, possibly strapped to your bed, while all your funds (& estate) drain away paying for your care.
As for your questions about lifespan, inflation, health care, taxes, etc., who knows? A friend of mine was born in 1920 and has slowed down some but still enjoys life and goes to his office when he feels like it. My mom is approaching 90 but still runs her own retail business. You or I could step in front of a bus tomorrow or live well past 100. Spending lots of money after turning 60 or 70 or 80 doesn’t necessarily improve your quality of life; I would rather own a few things than to have things own me.