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Low priced stocks have outperformed thus far in 2021. The lower-priced the better the performance. Why is this occurring?

I submit that it is evidence of the growing presence of newly minted retail investors attracted to the markets by beginner-friendly trading apps and zero commissions. Retail investors with small accounts have historically been attracted to low-priced shares because of their affordability and by the perception that owning more shares will enhance returns.

The presence of retail buying is not only being felt by low-priced shares, by in the options market through a great increase in the purchase of calls.

The recent strength of low-priced shares and demand for IPOs and call options will be recognized as telling signals for those who remember the internet bubble at the turn of the century. …


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The most discussed current level of extreme investor optimism is more than just anecdotal. A raft of quantitative measures confirms the scale of investor sentiment (chart below), as we have demonstrated in a series of previous posts. The current put/call ratio rests below levels that have preceded many previous market retracements.

Anecdotal evidence supporting “irrational exuberance” is plentiful. I am encountering more and more ads on the internet extolling the virtues of trading apps that are “beginner-friendly.” As well, a recent check of Amazon revealed that the #1 selling book on investing was devoted to day-trading.

The current optimism permeating markets is set against a backdrop that includes the most fragile global economic and geopolitical climate since WW2 and a pandemic that remains uncontrolled. …


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The Citi Sentiment Index is reflecting a level of investor optimism that dwarfs that of the previous peak of “irrational exuberance” at the turn of the century. Most remarkable is that this level of optimism is being generated when the global economic and geopolitical scene is at its most fragile since WW2 and the world is battling the deadliest pandemic in a century.

The bullish case rests on the intervention of central banks to massively expand the money supply and reduce interest rates to historic lows. …


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In yet another disturbing similarity to the late days of the internet bubble at the turn of the century, the chart below illustrates that margin debt has reached record-high levels while the P/E ratio of the Nasdaq is the highest since 2000.

A significant share of the margin debt that has accrued over the past year is the responsibility of new retail investors who are being encouraged to speculate in stocks using “easy to use” and “beginner-friendly” trading platforms. I am seeing more and more ads for these “services” appearing on the internet.

More ominous for the potential of a very sharp and swift market reversal is that the top 5 weightings of the S&P 500 account for roughly 23% of the index which amplifies potential market volatility (both down and up). …


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The cover of the December 4th, 2020 of major British financial publication MoneyWeek (see below) suggests that the coming decade will be a boom time for investors.

The use of magazine covers to help gauge investor sentiment has been used for decades. They have often proven to be a useful contra-indicator, with the most famous example being BusinessWeek’s 1979 cover story “The Death of Equities.”

The MoneyWeek cover is but one example of extreme optimism: almost every measure of sentiment is at levels last seen during the internet bubble era.

Historically, such extremes of optimism have not ended well.

Our view has been that the coming decade will be unusually volatile for investors, with significant economic and geopolitical issues producing a challenging investment climate. …


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2020 was a bumpy ride, have we put volatility behind us? We think not.

The global economy was being supported by enormous central bank intervention even before the pandemic. World debt levels are at unprecedented levels and the global geopolitical scene continues to deteriorate. The path of economic recovery remains uncertain. There is no shortage of potential catalysts to trigger further volatility. The chart below illustrates a factor that almost guarantees elevated volatility in the years ahead.

2019 marked the 8th consecutive year that the S&P 500 experienced below-average levels of volatility. A key characteristic of volatility is its mean-reverting tendency. …


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The current concentration of market leadership surpasses any historic precedent, even the tech inspired bubble top of 2000, as the chart below illustrates.

This chart also teaches an important lesson, that concentrated markets tend to reflect market extremes that are prone to correction. The 2000 top is conspicuous, but the chart also depicts pullbacks even after more mild spikes in concentration.

Our historical work confirms extremes of concentration creates vulnerable markets. At various times in the 19th- century canal and railroad stocks dominated markets, which were then followed by sharp declines. The Nifty Fifty market of the early 1970s is a well-known 20th century example. There are certainly more. …


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The number of companies required to mimic the performance of the S&P 500 had fallen to an all-time low at year-end 2019 to just 83. The ensuing strength of the FAANGs, Microsoft, Tesla et al mean the effective number is now even lower.

The narrowing of market breadth now exceeds the previous low reached at the peak of the internet bubble in 1999. The sharp decline of the number of companies required to replicate the performance of the S&P 500 over the past 5 years coincided with the accelerating popularity of passive investing strategies. …


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The chart below offers an interesting distraction in these turbulent times. The gradual change in the composition of the largest S&P weightings over-time offers a variety of lessons.

The change from 1980 to 2020 (roughly half a lifetime) illustrates the remarkable diminishment of the economic influence of the oil industry in favour of the dominance of companies empowered by the development of the internet.

The much greater weighting represented by the top 5 in 2020 than in previous years suggests that we can expect greater S&P volatility, both up and down, in the years ahead.

The most conspicuous lesson, of course, is the role that change plays in the capital markets and our lives. The most certain lesson from the chart is that the top 5 stocks in 2060 will look very different than in 2020. …

About

Jonathan Baird CFA

PUBLISHER OF THE GLOBAL INVESTMENT LETTER. AWARD-WINNING MONEY MANAGER. SPEAKER ON GEOPOLITICS AND MARKETS. www.globalinvestmentletter.com

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