By: Stash Graham
The three major domestic indices ended a 2-month losing streak and posted gains on the back of positive news regarding the development of the COVID-19 vaccine. Gold and bond prices fell on the expectation that society will reopen sooner rather than later. Additionally, markets appreciated materially following the news of a Joe Biden/Kamala Harris victory in the Presidential Election (Dow Jones Industrial Average was up 7% in the five trading days after the election). The Republicans avoided the “Blue Wave” and retained the Senate while picking up seats in the House of Representatives. The prospects of a lower stimulus package were overwhelmed by the possibilities of no material tax hikes and normalization of globalized trade. In the meantime, the Federal Reserve continues to provide ample liquidity to prop up financial asset prices. As a result of the Fed’s money printing, bank reserve creation, and debt monetarization, the U.S. Dollar fell to 3-year lows.
Enthusiasm among retail investors is reaching historic proportions. Unfortunately, as you will see, this tends not to be a good omen in financial markets. Per our friends at Sundial Capital Research, retail investors are currently buying two times (100%) more call options than put options. For simplicity’s sake, a call option is a levered bet that a stock price will go up. Put options are levered bets that a stock price is going to go down. Options are a type of financial derivative and are also primarily regarded as the most speculative form of financial instrument in the world. When you have a lot more call option buying than put option buying, especially 100% more, this confirms the market participant’s excitement about owning stocks.
With call option buying (compared to put option buying) at these rare levels, the Sundial team studied when the last time market participants were this aggressive. Not since December 15, 2000, have retail market participants been this aggressive with risky speculation. Naturally, this date right before the Dotcom Bubble burst and a terrible time to put new capital to work. A quote from a financial titan, Sir John Templeton, comes to mind: “Help people. When people are desperately trying to sell, help them, and buy. When people are enthusiastically trying to buy, help them, and sell.” As a result of excessive call option buying, premiums (what you initially pay to own the option) are very high compared to the premium of a put option. History has witnessed only 75 weeks where the cost of a call option was this expensive, as you would imagine 2000-01 produced a lot of these documented weeks. To our amazement, 74 out of 75 times that call options have been this expensive, markets have fallen in the weeks and months ahead. Overall, the median percentage return a year after call options reach these lofty levels is -11.75%. Market participants’ goals in investing are to “Buy Low and Sell High,” yet we know the vast majority do the opposite: “Buy High and Sell Low.” At a time of historically high risk-taking, we need to ask ourselves whether we are buying low when people are fearful or buying high when excitement is abundant.
Jobless Claims rose for the first time in back to back weeks since July. As we warned in previous letters, the lack of stimulus and the seasonal effects on the economic sectors that cannot afford downward sales pressure should produce continued stress on the job market. Total personal income has now declined two of the past three months and has contracted at a 12.5% annual rate since the economy and stock market bottomed in the spring. As a result of the lack of income growth, we should not be surprised by the latest small business revenue data from the team at Harvard-based, Opportunity Insights (TrackTheRecovery.org). We are updating our September letter to highlight a stagnating level of small business revenue and the overall number of small businesses open. Since the September letter, we have started to witness a decline in small business revenue (left) and, not surprisingly, in the number of small companies that have remained open (right). This dynamic can undoubtedly help explain why jobless claims are starting to head higher again.
Increasing business closures and renewed rising jobless claims are occurring at a time when there is no stimulus supplement available. Over the last couple of months since the end of the enhanced unemployment benefits, households could stay afloat due to the historic amount of savings generated because of the Spring stimulus package. In the latest Federal Open Market Committee meeting, committee members commented on these household savings. “Several participants expressed concern that, in the absence of additional fiscal support, lower-and moderate-income households might need to reduce their spending sharply when their savings were exhausted. A couple of these participants noted reports from their banking contacts that households appeared to be rapidly exhausting funds they received from fiscal relief programs.” In total, we have quickly dwindling savings balances and continuously growing credit card balances and delinquencies with foreclosure/eviction moratoriums set to expire in three weeks. These events are occurring concurrently or in advance of a financial market that is trading near their all-time highs with a historic amount of optimistic speculation. We remain cautiously concerned.
Invesco DB Optimum Yield Diversified Commodity ETF (Ticker: PDBC)- As we mentioned earlier in our letter, we believe commodities will represent a great value over the next few years. The Invesco commodity-focused instrument represents our diversified exposure to a basket of commodities. This month’s performance was very encouraging, and we added our exposure to PDBC (up to 5% allocation of total account value from an initial 2-3%).
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