The Bespoke Report · 2021. 1. 22. · The Bespoke Report Equity Market Pros and Cons January 22,...

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The Bespoke ReportEquity Market Pros and Cons

January 22, 2021

An independent research firm that uses big data to present timely investment ideas in an easy to understand format.


http://www.bespokepremium.com/



US Equities

Pros Cons1. Still a Bull Market2. Internals Still Confirming3. Strong Semis and Transports4. Earnings Delivering5. Stocks vs. Bonds and TINA6. Don’t Fight the Fed7. Consumer Ready to Roar8. Manufacturing Mojo9. Healthy Housing10. COVID Vaccines11. Small Cap Strength12. Sector Rotation13. Mega Caps Have Consolidated14. Full Dem Control (Really)

1. Equities Overbought Globally2. Valuations Stretched3. SPACs Soar4. This is Ludicrous5. Jobs Slow to Come Back6. COVID Risks7. Growth vs. Value8. A Lot to Live Up To9. Investor Euphoria

Our Equity Market Pros and Cons report helps provide a complete picture of the bull and bear cases for US stocks right now. It’s heavy on graphics and light on text, but we let the charts and tables do the talking.

Each slide deck is not meant to be weighted equally. While there are many more Pros than Cons in this quarter’s report, some of the Cons like Valuations Stretched, This Is Ludicrous, and Investor Euphoria represent serious headwinds in our view.



PROS – Still a Bull Market

“Don’t Fight the Tape” is still in place from a long-term perspective as the S&P 500 remains in a bullmarket and within its long-term uptrend channel. You’re fighting the trend if you bet against thismarket. Invoking another popular market axiom, remember, “the trend is your friend.”

-17.205

S&P 500: Last Year

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Jan-20 Mar-20 May-20 Jul-20 Sep-20 Nov-20 Jan-21

S&P 500: 200-Day Moving Average

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35% COVID Crash hardly registers when smoothed out by the 200-DMA



PROS – Internals Still Confirming

Whether you’re looking at large caps or smallcaps, market breadth continues to confirm thenew highs in the broader indices. Like theRussell 3000 itself, which encompasses large,mid, and small cap stocks, its cumulativeadvance/decline line also hit a new high thisweek. While not shown to the right, the samecan also be said for the S&P 500 and the smallcap Russell 2000.

Trends in the credit market also continue toconfirm the action we’re seeing in the equityspace. Specifically, we’re talking about spreadson high yield debt. As shown to the right,spreads (plotted on an inverse basis in the chart)have tracked the S&P 500 step for step since theMarch lows and are now at the lowest levelssince the COVID outbreak began in February2021.

Russell 3000 Cumulative A/D Line: Last 12 Months

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Cumulative A/D Line (Left Axis)

Russell 3000 (Right Axis)

S&P 500 vs High Yield Spreads: Since March 23rd

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S&P 500 - Left Axis

High Yield Spreads (bps) - Right Axis (Inverted)

High yield spreads tracking trends in equity

market. Lowest spreads since the pandemic.



PROS – Strong Semis and Transports

In the physical economy, the Dow Transports havebeen trending higher maintaining a steady uptrendoff the March lows. This suggests a positive macrobackdrop for the economy.

Transports have long been considered the lifebloodof the physical economy, but in the digitaleconomy it’s semiconductors that fill that roleacting as the nervous system for the entireeconomy. The Semis have been even strongerthan the Transports.

The Philadelphia Semiconductor index has ralliedmore than 100% off the March 2020 lows, and itsrelative strength versus the S&P 500 hit new highsthis week.

Semis have been one of the best leading indicatorsfor the broader market in the last few years, so ifthey outperform, that bodes well for the market.

Dow Jones Transports: Last 12 Months

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50-DMA200-DMA

Relative Strength: Semis vs S&P 500 (Last 12 Months)

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Semis vs S&P 500

S&P 500 (Right Axis)



PROS – Earnings Delivering

Even with Wall Street analysts increasing their EPS estimates in the month leading up to the lastthree earnings seasons, companies have managed to beat those estimates in record numbers asevidenced by our “beat rate” tracker shown below.

The current earnings season has so far produced similarly strong earnings results. Of the 15 largestcompanies (by revenues) that have reported so far this quarter, all but one has topped EPSestimates. The one company that missed EPS was Netflix (NFLX), which rallied 16.9% in reaction toits report because of enormous subscriber numbers and guidance.



PROS – Stocks vs. Bonds and TINA

While it may seem like large cap equitiesare priced at extremely aggressive levels(31x trailing earnings), the currentearnings yield or inverse of P/E ratio isonly just below the yield on investmentgrade corporate bonds.

As shown in the chart at right, earningsyields have traded over 4% throughcorporate bond yields and over 2%through ten-year Treasury yields in thepast. At current yields, that would be adoubling of valuation from current levels.

Of course, that doesn’t mean valuationswill double, but the fact is with interestrates so low, valuations should beaggressive, and that’s especially truewith the Federal Reserve continuing toaggressively stimulate the economy viaasset purchases and forward guidance.

Stocks Are Not Excessively Priced Versus Bonds

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8 S&P 500 Earnings Yield - Moody's Baa Corporate Bond Yield

S&P 500 Earnings Yield - 10y UST Yield



PROS – Don’t Fight the Fed

Support from the Federal Reserve is substantial andwon’t slow any time soon. Even with financialconditions at the easiest levels on record, reserveliabilities of the central bank are set to pass $6trn bythe end of the year, 4x where they stood in October of2019.

Rate policy is also likely to remain on hold for sometime, with the overnight index swap market (tied tothe Fed Funds rate) pricing just one hike over the nextthree years. Hike pricing will rise once the Fed tapers,but until then: don’t fight the fed.

Financial Conditions Are Extremely Easy

Fed Hike Pricing Is Very Weak

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OIS Market HikesPriced Over Period6m From Now to 3yFrom Now

Fed Balance Sheet Expansion Is Contining At A Rapid Pace ($ bn)

Note: Assumes $40bn MBS/$80bn UST purchases per month for

all of 2020 and 90% reduction in Treasury General Account

balance over next 52 weeks.

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7000Reserve Balances ($ bn) Projected



PROS – Consumer Ready to Roar

Households are starting 2021 with a very large storeof cash.

While the savings rate as a percentage of disposableincome has fallen from its all-time record of 33.7% inApril of last year, it was still at 12.9% in November,which would be the highest level in decades otherthan 2020’s other extremely high numbers.

In addition to the flow into savings remaining high,the aggregate household sector has seen its cashassets (checkable deposits, time and savingsdeposits, and money market fund holdings) surge ata record pace of 22% YoY through Q3.

In real terms, that liquid cash is more than $45,000per person in the United States, easily a record. Andwhile those numbers are likely skewed by extremelylarge cash holdings among the wealthiest, thegrowth of “other” assets in the bottom half of theincome distribution (a proxy for their cash assets) isat a record pace. All of this points to a consumer thatis loaded up with cash and ready to spend in 2021.

Households Are Sitting On Enormous Cash Reserves

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20Household Assets For Bottom Half of Income Distribution Excluding: RealEstate, Consumer Durables, Stocks/Mutual Funds, Pensions, Private Businesses(YoY % Change)

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25 Total Household Checkable Deposits, Time & Savings Deposits, and MoneyMarket Funds: YoY % Change

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50,000Total Household Checkable Deposits, Time & Savings Deposits,and Money Market Funds Per Capita, September 2020 $



PROS – Manufacturing Mojo

Both hard and soft data out of the manufacturing sector has continued to show a strong rebound fromthe depths of the pandemic. Some of the more impressive readings have come from the ISM andMarkit US manufacturing surveys. The December ISM report released earlier this month rose to one ofthe highest readings of the past two decades. Meanwhile, the preliminary Markit PMI for Januaryreleased Friday reaffirmed this trend, hitting its highest level since at least May of 2007. As for the restof the world, there may not be record readings, but on average the Manufacturing PMIs are consistentwith accelerating growth for both developed and emerging markets. Other hard data readings on globalmanufacturing like Japanese machine tool orders have echoed a broad rebound in activity.

Markit Manufacturing PMIs

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'07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19 '20

US, 59.1

Emerging Market Average, 51.96

Developed Market Average, 54.46

World Average, 54.59

Japanese Machine Tool Orders Continue to Bounce

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bn JPY, SA by Bespoke



PROS – Healthy Housing

Strong readings in housing market indicators can basicallybe listed off ad nauseum with further reinforcements thisweek. Mortgage purchase applications rose above theNovember high to reach the highest level since Novemberof 2008. Existing home sales remain off the October peak,but rose sequentially in December and sit around some ofthe highest levels since Q1 2006. Meanwhile, inventoriesare at record lows with non-seasonally adjusted single-family inventories dropping below 1 million for the firsttime ever. As for starts and permits, the 12-monthaverages for both readings have surpassed pre-pandemichighs. Given the size of the housing market, that’s a goodsign for the overall economy.

Existing Home Sales & Total Housing Inventories - Since 1999

MBA Mortgage Purchase Index (SA)

Housing Starts & Building Permits (12 Month Average, mln): 2010 - 2020

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Permits - Trailing 12 Months

Both Housing Starts and Building Permits Above Pre-Pandemic Highs

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Existing Home Sales mm SAAR, 6.76 (Left Axis)

Total Housing Inventory mm SA, 1.27 (Right Axis)

Housing Starts (12 Month Average, mln): 1967 - 2020

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Recession Starts - Trailing 12 Months

Starts peaked well ahead of every prior recession.



PROS – COVID Vaccines

Vaccine distribution continues to accelerate in the United States,and the current trend of acceleration in daily doses is consistentwith full immunization of the over-65 population by the end ofMarch as well as herd immunity by the end of summer. As thenumber of vulnerable or non-immune over-65s drops, COVIDdeaths will plummet.

The COVID epidemic is not “fixed”, but the current data isconsistent with full normalization on the horizon.

Administered Doses Accelerating: What Is Their Limit? Over 65s Fully Vaccinated By March, Herd Immunity By Q3?

Note: Takes current trend since New Years, extrapolates forward, and cuts off at noted per day

administered doses.

Note: Assumes current acceleration of trend, capped at 2mm doses/day, with 50% of doses

administered going to >65s.

3/26/2021, 97.926/25/2021, 75.26

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Herd Immunity

As Vulnerable Population Drops, So Will Deaths

Note: "Vulnerable" population is estimated Over 65s less estimated Over-65

Cases & Over-65 Vaccinations.

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Over-65 Deaths (Estimated& Modeled)



PROS – Small Cap Strength

One of the biggest arguments from marketbears over the last few years was thatsmall-caps weren’t participating, and “themarket” was just being buoyed by themega-caps and FAANG.

Similar to Semis and Transports, manyinvestors look for small-cap leadership tosupport a bullish thesis. Since the March2020 lows, they’ve certainly gotten that. Asshown in the top chart at right, the relativestrength of the Russell 2,000 to the S&P500 has spiked dramatically. And there’sstill room for this ratio to run.

Unlike the S&P 500 that is very top-heavywith Tech, the Russell 2,000 is more evenlybalanced, and Tech is only the 5th largestsector in the index.

Russell 2,000 Sector Weightings

1.8 3.1 3.5 3.6 3.85.9

12.514.4 15.3 15.5

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Ratio of Russell 2,000 to S&P 500: 1990-Present

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PROS – Sector Rotation

Last July, we first highlighted healthy rotation underneath the surface during the post-COVID bounceoff the lows. In other words, the broad market rally had not been thanks to just one sector. Duringthe COVID Crash, defensives like Consumer Staples and clear COVID plays outperformed. In the initialstages of the new bull market, Energy, Health Care, and Tech began to outperform. Come mid-May,there was rotation out of Tech and into laggards like Financials and Industrials with the reverse typeof rotation occurring throughout the summer. The early fall’s consolidation saw sectors like Materialsand even Utilities turn into market leaders. Since the end of October, there has been a good mix withEnergy, Financials, and Tech all the three best performing sectors.

S&P 500 Since 2/19/20 Peak

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2/20 3/20 4/20 5/20 6/20 7/20 8/20 9/20 10/20 11/20 12/20 1/21

Act I (2/19/20 - 3/23/20) - Cons. Staples (-24.3); Health Care (-28.1); Comm. Svcs. (-28.6)

Act II (3/23/20 - 5/13/20) - Energy (49.4); Health Care (31.7); Tech (30.2)

Act III (5/13/20 - 6/8/20) - Energy (29.8); Financials (29.3); Industrials (28.9)

Act IV (6/8/20 - 9/2/20) - Tech (24.8); Cons. Discret. (20.4); Comm. Svcs. (15.2)

Act V (9/2/20 - 10/30/20) - Utilities (3.8); Materials (-4.6); Industrials (-4.8)

Act VI (10/30/20 - 1/22/21) - Energy (47.2); Financials (28.2); Tech (20.4)


https://media.bespokepremium.com/uploads/2020/07/The-Bespoke-Report-072420-43tg3.pdf


PROS – Mega-Caps Have Consolidated

While they still make up a huge portion of the market, the “mega-caps” have had a chance toconsolidate over the last four months. The fact that the S&P 500’s uptrend remained intactthroughout this consolidation phase for “Big Tech” is another positive. Now that these behemothshave re-charged, they’re set up for big legs higher if earnings and guidance remain strong.



PROS – Full Dem Control (Really)

You’ve been told all these years that gridlockis good for the market, but that’s not quite thecase. Since 1901, the DJIA’s averageperformance during sessions of Congress hasbeen better under full control by Democratsor Republicans compared to differentcombinations of gridlock.

The 177th session of Congress will be the 21st

time that Democrats have had full control ofthe Oval Office, Senate, and House. In theprior 20 sessions, the DJIA gained roughly 17%with positive returns 65% of the time. Thatcompares to an average gain of 15.4% for allsessions of Congress since 1901.

One notable aspect of the 117th Congress,though, is how slim the Democratic majority isin both chambers - only a tiebreakeradvantage in the Senate and just 11 seats inthe House.

Start End President Control Majority Control Majority

63 3/4/13 3/4/15 D D 7 D 163 -30.62

64 3/4/15 3/4/17 D D 17 D 38 67.20

65 3/4/17 3/4/19 D D 11 D 3 -9.11

73 3/4/33 1/3/35 D D 23 D 196 95.28

74 1/3/35 1/3/37 D D 44 D 219 69.79

75 1/3/37 1/3/39 D D 60 D 244 -13.94

76 1/3/39 1/3/41 D D 46 D 92 -14.08

77 1/3/41 1/3/43 D D 38 D 106 -9.15

78 1/3/43 1/3/45 D D 19 D 13 28.67

79 1/3/45 1/3/47 D D 19 D 53 14.55

81 1/3/49 1/3/51 D D 12 D 91 36.54

82 1/3/51 1/3/53 D D 1 D 36 22.24

87 1/3/61 1/3/63 D D 28 D 87 7.73

88 1/3/63 1/3/65 D D 34 D 82 32.96

89 1/3/65 1/3/67 D D 36 D 155 -10.04

90 1/3/67 1/3/69 D D 28 D 60 21.04

95 1/3/77 1/3/79 D D 23 D 149 -18.24

96 1/3/79 1/3/81 D D 17 D 120 19.01

103 1/3/93 1/3/95 D D 14 D 82 16.28

111 1/3/09 1/3/11 D D 15 D 79 29.18

117 1/3/21 1/3/23 D D TB D 11

= Expected margins as of 1/6/21 Average 17.77

Median 17.64

% Positive 65

All Other Periods: Average 15.36

% Positive 70

Senate House DJIA

Change (%)

Full Democratic Control in Washington: 1901 - 2021

Session of

Congress



CONS – Equities Overbought Globally

We’ve seen some incredible moves higher in equity markets across the world over the last ninemonths, and this type of trend won’t go on forever. From a short-term timing perspective, prices forregional ETFs like the ones shown below are not attractive given how overbought they are.



CONS – Valuations Stretched

While Corporate America and the economylook much different (and healthier) nowthan it did in the late 90s, elevatedvaluations similar to what we saw thencannot be ignored. As shown at right, theprice to sales ratio for the S&P 500 is highernow than the peak in early 2000, and theTech sector’s price to sales is almost as high.

Warren Buffett’s supposed favorite valuationmetric is the ratio of total US stock marketcapitalization to GDP (read about the BuffettIndicator). This ratio was already at recordhighs pre-COVID, and with GDP down and stockprices up, it has only increased even further.

Price to Sales Ratios for S&P 500 and Large Cap Tech Sector

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S&P 500 (Right Axis)


https://www.gurufocus.com/stock-market-valuations.php


CONS – SPACs Soar

Highly speculative IPOs in the form of Special Purpose Acquisition Companies (SPACs) continue tosurge; those that have announced acquisition targets are up 125% over the past 12 months, and evennames that haven’t purchased private companies are up over 30% in anticipation of big post-announcement rips. Over $100bn of SPAC IPOs have hit the market in the past 12 months, with 67priced so far in January alone, a sign that speculation in this area is getting out of hand.

SPAC Issuance Goes ParabolicSPAC Prices Similarly Surge (%)

1/31/2021, 67

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Cumulative 12m SPACIPO Value ($ bn)

1/22/2021, 125.50

1/22/2021, 31.72

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SPACs With DealsAnnounced

SPACs Without DealsAnnounced

1/22/2021, 66.58

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IPOX SPAC Index



CONS – This is Ludicrous

The number of US-listed companies with a>$500mm market cap and >10x price-to-salesthat have doubled in the past month is up to 79.While there were substantially more such“ludicrous” moves at the peak of the Dot Combubble, this sort of widespread, parabolic priceaction is unsustainable and a sign of anexcessively exuberant market.

"Ludicrous" Names: Huge Numbers, But Far Below Dotcom Bubble Peak

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"Ludicrous" Names: % Change, Past Year

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CONS – Jobs Slow to Come Back

Labor market data’s improvement has certainly hit a speed bump of late. December’s nonfarm payrollsnumber and last week’s JOLTS report for the month of November showed an uptick in firings andlayoffs as openings remain well below the last cycle’s peak.

As for more recent data, weekly jobless claims continue to come in well above any time prior to thepandemic, and the pace of improvement has slowed. It has been nearly three months since claims lastmade a pandemic low.

Initial Jobless Claims + Pandemic Unemployment Assistance (mm, NSA)

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Initial Jobless Claims (Seasonally Adjusted, '000s) Since 1967

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Pre-pandemic record: 10/1/82, 695K



CONS – COVID Risks

While we view COVID vaccines and the path toherd immunity as a positive, we can’t completelyoverlook the idea that COVID risk still exists.

Going all the way back to March and April 2020and the thought that we’d maybe be getting backto normal by Easter, there have been severaltimes where the attitude was that we were overthe hump only for cases, hospitalizations, anddeaths to explode higher in second and thirdwaves.

There’s no concrete evidence that vaccines willstop working or the virus will become moredeadly, but the future is of course unknown andCOVID is still a risk.



CONS – Growth vs. Value

Over the past few months, the outperformance of growth over value has stalled, setting up what couldbe the peak of a decade plus run for growth. As shown in the inlaid chart, the ratio between the Russell3000 Growth index and the Russell 3000 Value index peaked in early September and has been in adowntrend ever since.

Growth vs. Value Higher Than 2000 Peak

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'95 '97 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19

Russell 3000 Growth /Russell 3000 Value

0.82

0.92

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1.12

1.22

1/20 5/20 9/20 1/21



CONS – A Lot to Live Up To

Earnings and guidance are ultimately what drive equity prices higher or lower. Positive analystexpectations and extremely strong forward projections from companies themselves have set the barvery high. Given massive runs higher in share prices for a large portion of the market, stocks currentlyhave a lot to live up to. When expectations are high, any hiccups can be disastrous.

S&P 1500 Earnings Revisions Spread Heading into Earnings Season

Net Percentage of Companies

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Q1 09 Q1 10 Q1 11 Q1 12 Q1 13 Q1 14 Q1 15 Q1 16 Q1 17 Q1 18 Q1 19 Q1 20

Most negative revisions spread since at least 2008.

3rd most positive

since 2009



CONS – Investor Euphoria

While the weekly AAII bullish sentiment reading is not at extremes, other readings show investorsentiment at historically bullish levels. For starters, the National Association of Active InvestmentManagers (NAAIM) Exposure index came in at the second highest level on record behind December 13th

of 2017 this week. Readings in the index above 100 or below -100 indicate managers are levered longor short, respectively. The index rose to 112.93 this week. In the history of the index going back to2006, there have only been 27 readings above 100 (meaning managers are levered long) and 11 ofthose have come in the past year. Additionally, Citi’s Panic/Euphoria index has reached a record highlevel of euphoria, far surpassing levels from the late 1990s/2000.

NAAIM Exposure Index Citi Panic/Euphoria Index

12/13/2017, 120.56

112.93

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Equity Market Pros and Cons

Our Equity Market Pros and Cons report helps provide a complete picture of the bull and bear case for US stocks right now. It’s heavy on graphics and light on text, but we let the charts and tables do the talking.

Each slide deck is not meant to be weighted equally. While there are many more Pros than Cons in this quarter’s report, some of the Cons like Valuations Stretched, This Is Ludicrous, and Investor Euphoria represent serious headwinds in our view.

Have a great weekend!

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The Bespoke Report · 2021. 1. 22. · The Bespoke Report Equity Market Pros and Cons January 22,...

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Transcript of The Bespoke Report · 2021. 1. 22. · The Bespoke Report Equity Market Pros and Cons January 22,...