Chart Of The Week   May 27 2020

Speculative Excesses?

Speculative Excesses?


Mathieu Savary, Global Strategist, BCA Research

The S&P 500 is seesawing around 3000, yet the economy is at its weakest in the past 90 years. Speculative excesses must be rampant. Not so quick.

First, theequity risk premium remains elevated, even when adjusted for the lack of stationarity of its mean. Equivalently, the expected growth of long-term cash flows embedded in the S&P 500 price is still extremely depressed. Speculative excesses are rarely present when investors take such a dim view of the future. Instead, these observations suggest that the real excesses are to be found in safe-haven bonds.

Second, market internals are inconsistent with widespread speculation. Cyclical stocks are massively underperforming defensive equities. Moreover,based on the Value Line Geometric index, the median stock remains 26% below its August 2018 high. Additionally, a very small proportion of NYSE equities trade above their 30-week moving average. Thus the euphoria appears to be limited.

Finally, our Speculation Indicator, which includes valuations, leverage among investors, cash on the sidelines, sentiment and, supply of equities, is at its lowest level since the 2011 selloff. Rarely have stocks meaningfully declined when speculation, as measured by this metric, was this low.

Based on the limited degree of speculative excesses and the massive fiscal injections as well as extraordinarily accommodative monetary policy around the world, any equity correction should remain limited in size. As a result, while the souring Sino-US relationship could cause a correction, it is unlikely to be greater than -5% to -10%. A re-test of the March 23 bottom is a low probability event.