- New Science in old markets -

Equities – after the squeeze and notes on the bubble

Equity prices in Europe and the US both pushed higher in response to the French first round election results. The result was widely expected to be exactly as it turned out, so obviously stock markets were simply 'caught short', as we also were. The market rise since then certainly has the brisk character of short covering, so what now?

The equity market compressions reported in the last edition have now broken upwards. We used the example of the NYSE composite but many other US indices have also compressed in the past two few weeks - in fact there were fresh compressions in the NYSE and the Spyders on Friday, visible only after the close:

NYSE & Spyder comps brk up

Short-covering can provide the early impulse for a sustained up-move so it is possible that we will now see a new 'leg' up in this long-lasting bull market. In these circumstances, a quick first rally may be followed by a dip - perhaps back to the most recent compression - and then another, bigger rally. This can be seen in the early part of the Spyders chart above, where two compressions formed, broke up, were re-visited and then the big move started.

We have some doubts about this easily imagined outcome however. There were weekly-scale top extensions in several US indices toward the end of the 'Trump rally' and these haven't yet expired:

S&P weekly top exts

That means this rally will have difficulty in making further headway and we are fast approaching that part of the year where there is a slight but marked seasonal trend for prices to fall through the Sumner, best expressed by the old London Stock Exchange aphorism: 'Sell in May and go away'. We have tested this and it does exist. A tendency is not a certainty, but it is one more bit of evidence.

Be very careful here - this rally could easily be a trap and we will wait for more clues before deciding what advice to give.

A further note on the situation in tech stocks and the emerging bubble:

The Nasdaq has made a new high on this rally, yet again. We stopped advising to buy dips in Nasdaq instruments at the last peak earlier this month and this now looks premature so we may shift back to that advice when we see a bit more clearly. The Nasdaq as a whole is a proxy for tech stocks and there are signs that a fever is developing about some individual tech companies that is leading the crowd to ignore brute reality.

Uber has recently claimed that the pace of its revenue growth is such that the growth in its financial losses is unimportant. This is a repeat of the argument that was common in the 1999 'dot com' tech boom that gaining market share is of paramount importance. Profits will follow when the company's position is dominant - presumably because it can then raise prices. Naturally that cannot be true for every company and there are very few that survived the shakeout last time around - Amazon being the obvious winner. Maybe Uber will be the victor in its sector but it has competitors and there are no guarantees of success - it may simply run out of cash, which is what broke the majority of tech firms in the 2000 meltdown. Meanwhile it is probably still valued at $55-$60 billion.

Tesla's story echoes that of Uber. Mr Musk has revealed aggressive plans to expand car production at a pace that has never before been achieved, partly by re-engineering the vital steps from prototype to production version. There are so many dangers here it is hard to know which one to pick. The car industry is not the dusty dinosaur it was once and the model development and production techniques that are in widespread use are well-tested and cost-effective. This is already a hi-tech industry and not to be easily overturned by a charismatic billionaire with some bright ideas. Tesla is making losses at a gargantuan rate and this unprecedented increase in production is needed just to stem those losses. Despite this, the valuation of Tesla has just exceeded that of Ford, reaching $52 billion. There are echoes of the AOL and Time Warner debacle in 2000 here as the new was mistakenly thought to be eclipsing the old in just a handful of years.

These sentiments are typical of a bubble. Bubbles can keep inflating for a long time before they burst, so it is unwise to be an early bear of the whole sector  - just keep in mind that a frenzy of enthusiasm for a stock, a person, a product or a sector usually ends in a crescendo of disappointment, blame and anger. See the end of our January 10th edition for a comparison of the Nasdaq and the S&P in the last bubble that ended in 2000 - the Nasdaq almost doubled in six months while the S&P rose and fell in a range. The eventual bear market brought both down but it would have been easy to lose a lot by choosing to sell the Nasdaq too early, as many did.

All signals generated by software supplied by our friends at Parallax Financial Research www.pfr.com