Corporate earnings for the first quarter of 2021 were released in earnest last week. If you listen to the earnings guidance from one soft drink company, there’s good reason to have a Coke and a smile. Coca-Cola blew past both its earnings and revenue expectations. But since I tend to advocate for the use of exchange-traded funds (ETFs), you may wonder why I care.
James Quincy, the CEO of Coca-Cola, called the company’s earnings a “super encouraging” sign that the world is reopening after being shut down due to COVID-19 precautions. Coca-Cola derives about half of its sales from locations outside the home — restaurants, stadiums, theaters. The reopening is not happening at the same rate for all countries, but he did note that for the U.S., the month of March was better than January or February. In the U.S., Coca-Cola is experiencing growth in the nighttime business, as people go out to restaurants after work. However, Coca-Cola’s lunchtime business continues to suffer as people continue to work at home and don’t leave their house to eat lunch.
But let’s not let the nuance obstruct the more significant story; people are getting more comfortable navigating a world that is getting vaccinated. As of Sunday, April 18, 2021, more than half of the total U.S. adult population has received at least one COVID-19 vaccination, according to the Centers for Disease Control (CDC). Nearly one-third of the total U.S. adult population are fully vaccinated.
An Irrational Market Can Get More Irrational
By any comparison, the stock market has been on a tear. I’ve probably annoyed you by making several previous bubble comparisons. But I’ve also said that I expect the stock market to go higher. I feel dirty saying that. I feel like the dumb crowd that chases returns. Group-think often assumes that what has happened recently will continue to happen indefinitely.
There is not a lot of value in the stock market. And there is extreme optimism. For a contrarian like me, too much optimism makes me feel that the stock market is susceptible to a pullback. Extreme optimism means the stock market is vulnerable to a big ol’ pullback. Yet, when (if?) we get that pullback, I don’t believe it will be the end of the bull market.
I am being careful not to fall into the trap of rationalizing bullish expectations. It is a common behavioral phenomenon to look at something illogical and try to connect a bunch of data points to paint a picture of a logical narrative. In other words, when we want to believe something, we’ll find a way to believe it even when it is stupid to do so.
I’m trying not to be stupid. I can handle a 10-percent pullback without making any portfolio changes. That’s the cost of doing business with the stock market. However, suppose the stock market is on the precipice of a 20-percent pullback. In that case, it’s my job to recommend some changes to defend the value of your portfolio.
I am nervously recommending that investors maintain the equity allocation recommended to them by their financial advisor. And, yes, that’s a bit of a disclaimer-type of language — I just don’t know who is reading this. I am doing my best to customize advice through a broad medium. My apologies for not being able to understand your specific situation better. Let me rephrase — I am holding the equity I own.
I have written about “investors leaving growth stocks and flocking to value stocks. Or so it seems.” There had also been moves from small-caps to large-caps. The rotation doesn’t appear to be evidence of a deteriorating market. Instead, it looks to be a sign of a broadening bull market. As of April 16, 2021, roughly 80% of the stocks comprising the S&P 500 were trading higher than their pre-COVID-19 prices. Capital is being allocated to stocks and sectors that offer better-perceived value. This contrasts with a fading bull market where you’d expect investors to buy a narrow group of stocks while increasingly adding to cash positions. This rotation is occurring while buying continues. Last week, I cited that “more money has gone into stock-based funds over the past five months than the previous 12 years combined.” It’s hard for me to sell my equity positions in an environment where stock participation is broadening, and more money is coming into the market.
But please don’t confuse my bullishness as a sign of complacency. Last week, I said that “I suspect the next 10 percent move for the stock market’s price has a coin flip’s chance of being either up or down before the market ultimately sees newer highs.” The stock market is overbought. A sizable pullback shouldn’t surprise any of us.
How overbought is the stock market? Heading into last week, the S&P 500 had been trading greater than two standard deviations above its 50-day moving average for 12 straight days, according to Bespoke Investment Group (BIG). BIG reminds us that once the index hits such an extreme, it doesn’t stay there for long. This is the longest streak since 2013. Before that, you’d have to go back to 2004.
BIG found 33 instances since World War II when the S&P 500 closed at least two standard deviations above its 50-day moving average for 10 or more days.
Based on this data alone, I shouldn’t be as worried as I am about a 10-percent correction. After such stretches of being extremely overbought, the S&P 500 averaged gains over the following week, month, three months, six months, and one year.
The extra froth in the market has me worried. Still, history suggests that the stock market can handle any correction there might be around the corner. These average returns suggest that doom for the stock market is likely more of a 2022 conversation than a 2021 probability.
There Might be Some Froth in the Market
I’m just going to leave this one here for you to reflect upon.
Thanks to David Einhorn of Greenlight Capital for pointing out that Hometown International, Inc. (HWIN) has a $106-million market capitalization (the below graphics courtesy of Yahoo! Finance).
Hometown’s financials don’t impress me. Its total sales for the last three calendar years is $67,953.
What do you think they do? Go ahead and guess.
“A” delicatessen store. Singular.
Here is an excerpt from Greenlight Capital’s quarterly investor letter that pointed this out:
“Someone pointed us to Hometown International (HWIN), which owns a single deli in rural New Jersey. The deli had $21,772 in sales in 2019 and only $13,976 in 2020, as it was closed due to COVID from March to September. HWIN reached a market cap of $113 million on February 8. The largest shareholder is also the CEO/CFO/treasurer and a director, who also happens to be the wrestling coach of the high school next door to the deli. The pastrami must be amazing. Small investors who get sucked into these situations are likely to be harmed eventually, yet the regulators — who are supposed to be protecting investors — appear to be neither present nor curious.”
Greenlight continued, “From a traditional perspective, the market is fractured and possibly in the process of breaking completely.” Let’s hope I’m right and the reckoning is staved off until 2022.
Allen Harris is the owner of Berkshire Money Management in Dalton, Mass., managing investments of more than $500 million. Unless specifically identified as original research or data-gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Adviser’s clients may or may not hold the securities discussed in their portfolios. Adviser makes no representations that any of the securities discussed have been or will be profitable. Full disclosures. Direct inquiries: aharris@berkshiremm.com.
