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US Stock Indices Overdue a Much Needed Correction



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US equities have been running absolutely rampant over the past few weeks.


As things stand, the S&P 500 index is shaping up for 6 straight weeks in the green. This most recent rally has taken the index to unprecedented levels in the mid-3500s from below 3200 in late July.


Nearly half of that rally has come in the last two weeks, with the upside picking up pace after the index surged above previous all-time highs of just under 3400, which were set back in February.


For the most part, the rally has been driven by big US tech companies such as Apple, Microsoft, Facebook, Amazon and Alphabet (Google’s owner). These stocks are up 65%, 22.6%, 28.4%, 41.2% and 15% respectively. Other stocks such as Tesla have seen even more “parabolic” gains.


Everyone and their mother has been seemingly been getting involved in buying Tech stocks; I’m used to seeing analysts and traders talking about being long (or short) AAPL and MSFT (the tickers for Apple and Microsoft), not Instagram models and celebrities.


I am a long-term US equity bull, but these short-term gains are clearly exhibiting classic bubble behaviour.


Naturally, with outperformance in US tech we are seeing the Nasdaq performing even better than the S&P 500!


The Nasdaq 100 index of US tech stocks today surpassed 12400. Just at the start of last month, the index was at 11000. Not even three months ago the index was under 10000.

Meanwhile, the Dow is back within striking distance of all-time highs. The index has been unable to garner as much traction in recent weeks due to its lack of weighting towards outperforming big tech stocks, something which Apple’s recent stock split has not helped (the Dow weights companies by stock price, not market cap. AAPL was weighted around 12% of the Dow until it split each stock into four stocks, now it is barely weighted 3%).


In terms of what is fuelling the rally, people will point towards the usual suspects;

A HIGHLY dovish Fed that has pumped trillions in liquidity into markets over the past few months.


Expectations for a vaccine to be promptly disseminated to the public enabling a quick return to “business as usual” for the global economy (most rational investors now see such hopes as a pipe dream given the “economic scarring” the pandemic is bound to leave in its wake – i.e. bankrupt businesses, higher government debt and unemployment levels).


A faster than anticipated economic recovery, particularly in the US (remember when NFP beat expectations by 10mln a few months ago, and has continued to deliver strong employment gains ever since).


Sure, the first of these results in very low rates, which according to financial theory does boost stock valuation. The Fed has only recently adopted the even more dovish stance of seeking to average inflation over-time.


However, it is unclear at this point how the latter two points can STILL be boosting stock prices.


In other words, with valuations surging, US stock prices have CLEARLY decoupled from the fundamentals…


Now I’m not saying this bubble is going to pop tomorrow, but things are clearly getting a little out of hand. Expect some choppy action ahead! 

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