Jeremy Grantham’s GMO has been warning for some time that US investors face subdued long-term returns due to elevated prices.
Valuation warning signals are now being confirmed by excessively bullish sentiment, writes Edward Chancellor in GMO’s latest quarterly client letter.
GMO's sentiment indicator looks at leverage, momentum, IPO issuance and returns, and a host of other measures. "Sentiment has reached an extreme level, fast approaching two standard deviations above its long-run average," says Chancellor. It's not as manic as the late dotcom days, but it is above December 1996 levels, when Alan Greenspan famously warned of "irrational exuberance" in the markets.
In fact, current bullishness has only been exceeded in the “great garbage market” of 1968, and between 1998 and 2000.
This doesn't mean markets will collapse, Chancellor admits. In the past, however, investors who bought into markets at current sentiment levels suffered negative real returns over one, three, and seven-year periods.
Twitter learns the downside
The Twitter slaughter continues, the stock losing almost a quarter of its value last week following the expiration of the lock-up period that prohibits early investors from selling stock.
Although Twitter’s largest shareholders attempted to reassure investors by saying they would not be selling, trading volumes were predictably heavy.
However, it would be naive to pin last week’s hammering solely on this, given that other young internet companies have emerged relatively unscathed from their own lock-up expirations in recent years.
Facebook gained when its lock-up period expired in November 2012; Google stock was largely unaffected during its 2004 lock-up expirations; neither LinkedIn nor Groupon, both of which suffered heavy lock-up selling, came close to anything like the Twitter sell-off.
Last week's falls show just how ugly sentiment is towards Twitter and growth stocks in general, with the Nasdaq Internet Index plunging to fresh 2014 lows. Even now, previous high-fliers, such as Twitter and Amazon, continue to look expensive by most valuation metrics. As money manager and blogger Josh Brown put it, "The growth guys are sick of being long 'promise' and the value guys have no interest in adopting these orphaned dotcoms until valuations get much lower."
Volatility, what volatility?
Has volatility returned to markets? Some commentators think so, referencing falls in tech stocks as well as recent topsy-turvy action that saw the Dow Jones record three 150-point swings over a single day.
In truth, volatility remains subdued. S&P analyst Howard Silverbalatt notes daily moves average just 0.95 per cent.
Yes, it’s more than last year’s 0.85 per cent average, but that was the lowest figure since 1995.
Moves averaged 1.07 per cent in 2012 and 1.64 per cent in 2010, with the 50-year average standing at 1.47 per cent – more than 50 per cent above current levels.
There is some volatility below the surface. Although the S&P500 is flat this year, 103 stocks have gained 10 per cent, with another 51 suffering double-digit declines.
“The battle from within has been ranging,” says Silverblatt, “and that has added to the perception of volatility.”
Bull market tiring
US markets are hovering near all-time highs, but technical divergences indicate the five-year-old bull market is tiring.
Fewer stocks are participating in the advance. Last week, the small-cap Russell 2000 index closed below its 200-day moving average for the first time in 363 trading days. Market analyst Peter Boockvar notes that just 76 NYSE stocks were trading at 52-week highs, compared to 187 on April 2nd and 282 on December 31st.
Just 65 per cent of stocks were above their 200-day moving average, compared to 74 per cent on the above mentioned dates.
Typically at market tops, very few stocks are making new highs, with indices grinding higher due to the strength of a small number of large-cap stocks. If the current bull market is to continue, breadth needs to improve.
Hedge funds profit from leaks
Last year, Citigroup was fined $30 million for divulging negative news regarding iPhone sales to a number of investment firms. A new study indicates this was not an isolated case of so-called information leakage.
The researchers looked at more than 70,000 analyst recommendation changes from 2006 through 2011, and then examined the trading patterns of 57 large hedge funds. Hedge funds tended to buy and sell in advance of recommendation changes.
Such trades were more temporary than their other holdings, and vastly more profitable – they earned annualised abnormal returns of 9.96 per cent for upgrades, and avoided losses of 11.28 per cent for downgrades. In contrast, no abnormal returns were recorded for other stocks held by hedge funds.
In other words, it's not a level playing field. Those in the know will always have access to better information – something worth remembering the next time you are tempted to jump into an upgraded stock.
See http://goo.gl/P41njt
