Everyone’s Betting on a Bubble That Can’t Burst

The global love affair with stocks and risk assets shows no signs of abating with day traders sitting in their basements to suit-wearing institutions (whose staff are also now working in their basements thanks to the pandemic) dive deeper into the market.

Despite multiple warnings of frothiness in stocks, equity funds are drawing fresh monies at an unprecedented pace and hedge funds are boosting their stock exposures to set new records.

Companies themselves, taking advantage of favorable bond markets, are becoming the biggest buyers of their own shares as well, with share buybacks, double the pace of a year ago – announced buybacks have averaged US$6.9 billion a day this earnings season, the most since at least 2006 according to data compiled by EPFR.

Several macro factors are of course driving this push to stocks – with growing confidence in an economic recovery buttressed by fiscal support and effective coronavirus vaccines.

But to understand the magnitude of the markets we’re living in, data from Bloomberg suggests that with the S&P 500 up some 75% from March last year, gains from the benchmark index dwarf all previous bull markets at this stage of the cycle since the 1930s.

That said, the boom cycle is relatively juvenile – just 11 months from the last bear-market bottom in March, but the velocity of the recovery has more than made up for its lack of vintage.

By one historical measure, it’s likely this bull market cycle is only halfway through, as the median return of the 13 previous U.S. stock market bull cycles was 126%.

And bears are increasingly an endangered species, with short sales dwindling to fresh lows and hedge fund managers scared into submission by the Reddit brigade that has resulted in billions of dollars’ worth of losses from the GameStop (-0.25%) saga.

A survey by the National Association of Active Investment Managers has interestingly determined that even the most bearish group that typically has a net-short position, was 80% long in stocks earlier this month, before turning neutral.

So, should investors be worried? Yes and no.

One oft heard adage is that markets generally crash after the last bear becomes a bull.

And right now, there are scarcely any bears to be found.

Like the coronavirus pandemic, if or when a market correction occurs, it will likely take the market by surprise, yet all of the clues would already have been there but only with the benefit of hindsight.

A German proverb notes that trees do not grow to the skies – but that’s also because they can only absorb a finite amount of nutrients, water and sunlight, beyond which any additional feeding of the tree does not result in any further growth.

Markets on the other hand are not so restricted by such natural limitations – because as long as central banks continue to print money, there is theoretically no limit to how much earnings can be disassociated with the price of assets.

It stopped mattering some time ago, valuations are now more of a footnote than a key determinant of a stock’s price.