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The recovery rally reaches thin air

September 09, 2020

the stock market's recent wild mood swings chart

The stock market’s unprecedented recovery since the March 23 low has also come with a remarkable shift in investor sentiment. The steady climb in the S&P 500® Index over the summer months pushed many investor sentiment indicators to extreme levels, including the CNN Fear & Greed Index, Investors Intelligence U.S. Advisors’ Sentiment and put/call ratios. Citigroup’s proprietary “panic & euphoria” indicator, which tracks metrics from margin debt to options trading to newsletter bullishness, jumped to a record high of +378 on August 28th, just five months after hitting a record low of -639 on March 20th. (See Chart 1 above.)

There are clear signs of frothiness in certain areas of the equity markets; for instance, Apple reaching $2 trillion in market capitalization and Tesla rising 800% over the past year. Through September 3rd, the NASDAQ Composite Index was up 30% for the year-to-date, outperforming the S&P 500 by nearly 20 percentage points. Last week’s sharp declines on little news indicates there is substantial optimism embedded in this group of market leaders.

While the current bubble may look similar to the late 1990s, today’s market leaders appear far more stable than those of the dot-com bubble days. The NASDAQ’s price/earnings ratio is at an elevated 35-times earnings, but this is nowhere near the 74-times P/E ratio at the NASDAQ’s peak in 2000. Moreover, investor activity isn’t necessarily following investor sentiment; for example, the BofA Bull & Bear Indicator, which measures investor flows versus sentiment on a 10-point scale, currently sits on the bearish side at 3.9. Following the extreme upward move from the March market bottom, it wouldn’t be unexpected or unhealthy for the market to pause in the near term to consolidate its recent gains.

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