Markets Brewing - Further Signs Of Euphoric Rally
Back on 26 June I wrote about the euphoric rally that is still to come that will be the cherry on the top of this global equity bull market, a bull market that has existed for virtually everyone except Australian ASX investors. Following the expected short-term weakness surrounding Greece and the realization that the Fed will raise rates in September, conditions are near perfect for an enormous rally – particularly in some key sectors – over the course of the next six to nine months.
What are these perfect conditions?
Firstly, this is the most hated bull market in history. Traders, fund managers and analysts have continually either picked tops on the market, been severely underweight equities or worse short. The chart below shows the consistency in the negativity towards markets and the ongoing high levels of short market positions. We are now at the highest levels in short interest since 2009 – certainly not the conditions upon which markets end bull market runs or even experience short-term pullbacks. As markets creep higher these shorts are squeezed and need to cover adding additional fuel to the rally.
Second, the US economy continues to improve while interest rate normalization by the Federal Reserve post the September rate increase will be very slow and gradual keeping monetary conditions very accommodative. Moreover, the first rate hike is a vote of confidence to the strength of the US economy and the relief that comes once the first rate hike is made. The whole world seems to be focused on the timing of this first rate hike. Our research shows equity markets typically perform their strongest in the 3 months before and up to 6 months following the first rate increase in a tightening cycle.
Third, we still have massive European Central Bank quantitative easing. This injection of liquidity is fueling global equities. Just like Bank of Japan easing in the 1990’s saw a massive flow of funds into the US and a depreciation in the Yen – the exact same circumstances are unfolding again. Funds flowing from the ECB bond buying program is flowing into European equities but more so into the US where investors benefit from a strengthening US dollar on top of their equity/real estate portfolios.
Finally, as we discussed a fortnight ago we are starting to see some real sector rotation within equity markets. The underperformance of transports, utilities and resources (including oil) will fuel flow of funds into those stocks and sectors which are outperforming. In that 26 June column we highlighted US biotechs, pharmaceutical companies and social media stocks like Facebook as stocks ripe for a substantial rally. In the past week each of these have hit fresh record highs.
Within the biotech space further mergers and acquisitions have been occurring almost every second day. This either means that biotech CEOs are overly optimistic and is a sign of exuberance (like RIO buying Alcan in late 2007), or that value still appears in the sector. Now most would say the former especially when looking at the Nasdaq biotech index below which has increased 300% in the past three years. However, these companies are hugely profitable have enormous cash reserves and are trading on cheap multiples. Consider that the biotech index was trading at more than 60x earnings in 2000 and over the past twenty years has averaged an earnings multiple of 30x. However, currently earnings are just on 20x and are far more profitable than ever. There is ample room for multiple expansion before levels are reached that are considered overbought or bubble territory. I believe we will reach these conditions over the course of the next 9 months still leaving enormous upside for traders to extract profits. Don’t be fooled by the charts appearance there is real fundamentals backing this price rally.
Facebook is another favourite of ours and from its current record price of $90 – up from $80 three weeks ago – we see levels well through $100 following its earnings release on July 29. Facebook is dominating direct based advertising and through new avenues – video ads, Instagram and Snapchat – are experiencing strong growth in ad revenue. Consider the performance of traditional advertising companies such as radio and TV broadcasters and their consistent issue of profit warnings is a reflection of contracting margins and lack of commitment from buyers.
Because new advertising channels like Facebook are gaining market share. The next generation rarely watch free to air TV – with the dominance of Youtube, Netflix, Foxtel, and other internet based communication tools – traditional methods of brand advertising is changing. Facebook is at the forefront of this and are dominating. Yelp, Linkedin, Twitter have not yet been able to successfully monetize their online platforms yet Facebook is going from strength to strength and even eating into Google’s traditional Adwords system. Throw in the Oculus gaming headset business and Facebook has multiple platforms from which to continually expand profit and revenue growth over the coming quarters. I expect a huge market realization of Facebook’s potential on its result. It seems others are too with several broker upgrades above $100/share in the past fortnight, getting in these upgrades before the company results are released.
The opportunities for equities are brewing quite nicely according to my expectations and importantly we can locate with some degree of confidence where the “euphoria” will emerge. It will be a great period to see some extraordinary capital gains that may go down as one of the biggest bubbles in history.
Greg is the Head of Proprietary Trading at Global Prime and has over 20 years of experience as proprietary trader and high level strategist for the major investment banks including Citigroup, Bankers Trust and Macquarie Bank. He has been involved across all asset classes including commodities, bonds, currencies and equities right across the globe.
After a 10-year career within the comforts of the large investment banks and research firms he branched out on his own to form his own proprietary trading firm successfully building the business into a multi-million dollar trading operation that turned over a billion dollars a year. This same team now runs the proprietary trading desk at Global Prime, risking their own money in line with the firm's and client's capital.
Greg has appeared on CNBC, Channel 9 - Business Sunday programme, a guest columnist for the Australian Financial Review, a regular author for Personal Investor, Wealth Creator and Shares magazine and is the former Treasurer of the Australian Technical Analysts Association.