In late 2017, the stock market melted up in a FOMO (Fear Of Missing Out) stampede as enthusiasm about the Trump tax cuts gripped investor psychology. The market corrected in early 2018 and rose steadily into October, though the advance could not be characterized as a melt-up. In late 2019, the market staged a similar FOMO stampede and the rally was halted by the news of the pandemic spreading around the world.
In each of the above cases, the Fear & Greed Index followed a pattern of an initial high, a retreat, followed by a higher high either coincident or ahead of the ultimate stock market peak.
Could we see a similar year-end melt-up in 2020?
A new cyclical bull
It’s starting to look that way. Evidence is emerging that the stock market is at the start of a new cyclical bull. Exhibit A is the Dow Jones Industrials Average and Transportation Average. Recently, both made fresh all-time highs. That’s a Dow Theory buy signal, a classic indicator of a new bull market.
The economy is starting to turn up from a top-down macro perspective. The tsunami of monetary stimulus has produced a surge in M2 growth, it was an open question of when any of the money growth would affect the economy. M2 monetary velocity is finally turning up. This is a signal of a growth revival. (Recall PQ = MV).
The latest update from FactSet shows that earnings estimates are recovering strongly.
Marketwatch reported that Goldman Sachs strategists headed by Alessio Rizzi believe that a sizable correction is not on the immediate horizon. To be sure, many sentiment indicators are at historical highs, but that should not be a major concern because of the positive macro environment.
Rizzi and his team said that indicators like put/call ratios tend to provide the most useful signals of where the market is moving when they are extreme, and that “that bullish positioning levels tend to remain strong for a long period if macro remains supportive.”
The macro environment may be headed in that direction. The European Central Bank increased stimulus on Thursday, and Treasury Secretary Steven Mnuchin is offering a $916 billion stimulus package to Congress to try to break a legislative deadlock.
In other words, buy the dip!
Indicators of institutional positioning are supportive of further market gains. John Authers recently highlighted the results of a “global survey of institutions by Natixis SA, which interviewed 500 managers” which found an unexpected level of guarded cautiousness among respondents.
Of these, 79% don’t expect GDP to have recovered to its pre-Covid levels by the end of next year, making them more bearish than typical sell-side researchers…There is a belief in a rotation toward value, but that co-exists with a belief that geopolitical tensions will worsen, amid rising social unrest, as democracy weakens. Both socially and economically, the people running very large institutions plainly believe the market is ahead of itself in expecting the effects of the pandemic to soon be vanquished: