What Happens After a Double-Digit Return Month?

• Double-digit return months often signal more upside
• Valuations exceed the ‘dot com’ bubble… what’s different today?
• Bipartisan support for $900B stimulus… will that risk $2T+ for Q1?

It’s exceptionally rare to see double-digit broad market returns in any one month. 

In fact, we have only seen seven the since 1992…  with one of those earlier this year (April)

Prior to 2020, the most recent double-digit return month was in October 2011, as the market recovered from a U.S. Treasury downgrade. 

From there, we need to go back a further twenty years to December 1991. 

During this time – investors were optimistic the recession of 1990 was primed for a quick recovery. Stocks surged and continued to follow through (as I will show below)

Prior to that we also saw double-digit returns in January 1987; August 1984; and August and October 1982 (with Reaganomics)
 
But here’s the thing: 

Double-digit return months do not necessarily imply large imminent corrections.

In fact, in almost every case (as I will show below) – the broader market continued to rally in the months ahead. 

Below is what we saw after the double-digit rally of October 2011: 

S&P 500 – The Rally Post Oct 2011

Following October 2011’s strong gains – the rally paused for two months.

However after that – strong momentum ensued. 

As an aside, note what we saw with the VIX during this time. It peaked at 45 prior to October (as the market feared Euro defaults) – however soon fell to levels below 20.

With a VIX below 20 – it gives institutional investors more confidence to put further money to work.

I highlight this as I think we could see something very similar today – with the VIX now trading just a tick above 20.

Let’s now look at what we saw with December 1991…

S&P 500 – What followed the Double-Digit Month of Dec 1991

Stocks leveled out for almost 12 months after the month’s double-digit gains… however the monthly trend held and stocks continued to climb higher. 

The key takeaway (for me) is don’t bank on some massive stock reversion following November’s stellar gain of ~11%.

As regular readers know – I think we will see more gains in 2021.

And whilst we might see a small pullback or even a “pause”… any dip will likely be bought.  

That said, there are many risks.

And one many “fundamentalists” are watching closely are valuations.

They are ‘sky-high’ by just about every metric… as multiples are ignored in a zero-rate environment (more on this shortly with an example) 

Valuations in “Rare Air”

Today’s exam question is whether the price action today is in the realm of “irrational exuberance” like we saw during the dot com era of 2000?

For example, below is a chart from Bloomberg showing the price-sales and price-forward earnings multiples for the S&P 500 after Fed Chair Alan Greenspan warned of overbought conditions in Dec of 1996

What’s interesting is prices more than doubled post Greenspan’s 1996 warning: 

The Irrational Exuberance of 2000

But as we see with Bloomy’s chart – the P/E ratio today is almost as high as it was during the dot-com peak. 

However, the price-to-sales multiple is at a fresh record…. as they head towards 3x sales

But there is one big difference between now and then…

Where do investors put their money?

Here I am specifically talking to a phenomenon known as “TINA”; i.e., ‘there is no alternative’

Why TINA?

Look no further that what we see long-term bond yields (and rates)

US 10-Year Yield over 20 years

In the year 2000 (the time of the dot com bubble) – investors were able to invest in the 10-year for a yield of 5-6%. 

Today that yield is 0.92% or negative in real terms (i.e. when adjusted for inflation). 

And with rates likely to rise… should we see a little bit of inflation returning (or at least the threat of inflation) – bond prices are likely to tank. 

Now with borrowing costs so low (i.e.. bond yields at record lows) – this tells us that future earnings should be discounted at a lower rate which implies corporate valuations should be higher.

As a complete aside (and to demonstrate incredibly low borrowing costs) – today Salesforce bought Slack for $27.7B.

But here’s the thing… 

Salesforce financed this acquisition on 8-year paper at just 1%.

And this type of thing is happening at scale across the board. And you wonder why we are seeing crazy multiples. 

The question you should be asking is what valuations make sense? 

And this is very hard to answer. 

I wish I could tell you. However I can’t. 

One commonly cited model comes from investment academic Robert Shiller. 

He developed the cyclically adjusted price-earnings ratio (CAPE ratio) – and provided this chart last week.

For those less familiar – Shiller’s CAPE takes a multiple of average earnings over the previous 10 years, and corrects for the market’s tendency to take account of the economic cycle, with lower P/Es when earnings are expected to fall and higher ones when they are expected to rise.

But note the relationship to long-term interest rates (in red).

It’s worth noting the average CAPE ratio over history has been 17.1x…. basically what we saw between 1880 and 2000. 

But with yields being artificially suppressed (to record lows) – this is having a meaningful impact on asset prices and the multiples investors are willing to pay (or perhaps more accurately – be completely ignored)

Note: the average 10-year yield has been 4.52% (the late 1970s and early 1980s) 

The market was up again today….

And perhaps it was on the fresh news of bipartisan support for $900B in stimulus.

The US dollar was sold on the news… and precious metals caught a bid. 

Note – I suggested gold was a buy last week. 

What will be interesting is whether the market also gets its “$2+ Trillion” in stimulus early in Q1…  and whether that’s now at risk? 

We will see.

And that could hinge on what we see with the November monthly job report at the end of this week. 

Expectations are for 500,000 private sector jobs to be added. Anything stronger and perhaps “stimulus cries” will fall on deaf Senate ears?

Separately, what I also think drove the market higher over November was excessive shorts on pandemic-hit stocks (e.g., airlines, hotels, cruise lines, small caps, retailers, malls etc) being covered.

News of a vaccine saw short traders cover these positions.

For those less familiar, short covering rallies are generally ferocious. However, I think this trade is now mostly done. 

What we’re likely to see now is a possible shift back into the more ‘quality’ names like Apple, Amazon, Google and Microsoft. 

In summary, it’s most likely we see follow through on November’s strong month.

And whilst the market could pause or even dip slightly (e.g. 5%)…  investors will be keen to put more money to work in the absence of real alternative. 

Regards,
Adrian Tout