B of A Securities’ U.S. quantitative strategist Savita Subramanian detailed an alarming number of ways that current markets resemble the year 2000, just before the tech bubble popped.
At the same time, Morgan Stanley’s equally prominent U.S. equity strategist Michael Wilson thinks recent volatility is just a leverage-clearing pause before the equity rally continues.
Over time, the Goldman Sachs Hedge Fund Industry VIP ETF should indicate which forecaster has this right.
The frenetic surge in retail investor speculation we saw last week is only one market trend that reminds Ms. Subramanian of the period just before the popping of the technology bubble in March 2000. The strategist notes that U.S. companies reporting both sales and earnings above expectations this quarter have underperformed the market in the following trading days. “The last time we saw similarly perverse reactions”, she writes, “was at the peak of the tech bubble.” The S&P 500 fell 17 per cent after the peak through the remainder of 2000.
B of A uses a proprietary Sell Side indicator that interprets Wall Street strategists’ asset allocation recommendations to measure broad market sentiment. The indicator is now bordering on the first official sell signal since August 2007, right before the financial crisis.
Perhaps most importantly, Ms. Subramanian emphasizes that the price-to-earnings ratio of U.S. small cap stocks is at 20-year lows relative to large caps. She notes that a return to the historical average valuation difference would see the S&P 500 fall 10 per cent.
Mr. Wilson at Morgan Stanley admits that the current investor euphoria does resemble 2000 but elsewhere he sees important differences. U.S. household balance sheets are far healthier than in the late 1990s and equity inflows now are a fraction of what they were then.
Morgan Stanley believes that January’s market volatility was caused by excess leverage. Mr. Wilson reports that hedge fund leverage - what they borrowed to invest - was near record highs at the end of 2020. Cash positions for long-only mutual funds were also plumbing record lows.
The short squeeze initiated by the Wall Street Bets message board (the largest in 25 years according to Goldman Sachs) forced funds to sell assets in order to de-risk and deleverage portfolios, causing the broader market to drop. Mr. Wilson believes this process has a way to go, but that the equity market rally will resume once fund managers have readjusted the risk profiles of their portfolios.
I will be watching the Goldman Sachs Hedge Industry VIP ETF closely in the coming weeks. This vehicle’s portfolio includes the most widely held stocks by hedge funds and it should be under pressure for as long as the deleveraging continues.
The ETF price should stabilize at some point, indicating that fund managers have recalibrated their portfolio risk and are looking to get active. If the market rallies afterwards, this would support Mr. Wilson’s thesis of a temporary market hiccough caused by overleveraged funds. Significant market weakness after this ETF stabilization, or if it continues to drop and doesn’t stabilize at all, would imply Ms. Subramanian’s more bearish outlook is the one to follow.
-- Scott Barlow, Globe and Mail market strategist
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The Rundown
Is this a bubble or not? Three things wise investors should keep an eye on
When will this bubbly stock market return to reality? That all depends on what you think is creating the froth – and, for that matter, on whether there really is a stock market bubble at all. Ian McGugan separates the various explanations to offer some clues as to when this current period of market exuberance may end.
When losing is winning: Shares of unprofitable companies soar
The market is having a George Costanza moment. The key to making money over the past year has consisted of doing the reverse of whatever common sense or Warren Buffett would suggest. Forget about buying companies with rising profits and strong prospects. The big bucks have gone instead to folks who have loaded up on flawed, unprofitable stocks with uncertain prospects. Does this make sense? Ian McGugan looks for answers.
Also see: Frenzied retail trading, outrageous valuations, easy money drive market madness
Canadian money managers weigh in on the latest market mayhem - and what they’re buying and selling
Reddit is coming for silver. A short squeeze? Unlikely
Silver prices have rocketed to their highest since 2013 as retail investors, egged on by messages on Reddit, pile into the market in an attempt to push up prices, although most analysts and traders say the rally will run out of steam. Peter Hobson and Swati Verma of Reuters report why.
Four ETFs for confused investors
Many Canadians have money to invest. They just don’t know what to do with it. That’s the conclusion of a new Scotiabank report on investor sentiment that was released last week. The survey found that 55 per cent of Canadian investors feel optimistic about their financial future, but many remain cautious. Most people (70 per cent) admit it’s hard to know what to do when it comes to their investments in the current environment, while 33 per cent say they are holding off on investing right now due to uncertainty caused by the pandemic. But have no fear. Gordon Pape is here with four ETF suggestions that you can invest in now, despite the market uncertainty. These will provide income and modest capital growth for years to come, with limited downside risk.
Base metals analysts turn cautious after stellar rally
Put the champagne back on the ice. After a super-charged rally over the second half of 2020 base metals may struggle to notch up further price gains in the short term. While the demand recovery is expected to spread from China to the rest of the world this year, analysts participating in last week’s Reuters base metals poll were cautious, expecting high inventories and rising supply to keep a lid on prices. Andy Home of Reuters reports.
Others (for subscribers)
John Heinzl’s model dividend growth portfolio as of Jan. 31, 2021
The highest yielding stocks on the TSX, plus risk data
Monday’s analyst upgrades and downgrades
Expected returns for income stocks in the S&P/TSX composite index
Monday’s Insider Report: Chairman invests over $4-million in this financial stock yielding over 4%
Here are the mutual funds you looked up the most on Globe Investor in 2020
Globe Advisor
Five ways to invest in companies committed to the advancement of women
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Ask Globe Investor
Question: I’m retired with no income and have been taking money out of my RRSP as the need arises. I find myself in a situation where I have some excess mutual funds in a cash account, which I would have to pay capital gains on when I sell them. Would it make sense to put those funds into the RRSP? – Susan D.
Answer: Before you transfer the mutual funds to the RRSP, consider the tax consequences. The Canada Revenue Agency considers the transfer as a sale and, since you’ve made some profits, you’ll be assessed capital gains tax when you file your 2021 tax return. Withdrawals from the RRSP count as income, but if you’re not taking out a lot, you may not have to pay much, if anything. But check it out first.
You’ll eventually have to pay tax on the full amount (current value plus future profits) when the money is withdrawn from the RRSP. In effect, you’ll end up paying tax twice. But again, if your income is very low at that time, no tax may be payable. Do some projections before acting.
--Gordon Pape
What’s up in the days ahead
Rob Carrick takes a closer look at the challenges posed by the record-breaking stock-trading frenzy at online brokers in January.
Click here to see the Globe Investor earnings and economic news calendar.
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Compiled by Globe Investor Staff