Skating By The Trap Door (Motherlode II)

Brief Observations

Our investment discipline is to align our outlook with current, measurable, observable market conditions – particularly valuations and market internals – and to change that outlook as conditions change. In prior market cycles across history, one could also respond immediately to “overvalued, overbought, overbullish” market extremes, which provided a kind of “limit” to speculation even before market internals deteriorated explicitly. Amid speculation driven by zero interest rate policies, speculation lost its “limits,” and we abandoned our bearish response to overextended syndromes except in periods when market internals are also unfavorable. It’s the striking uniformity of hostile conditions – extreme valuations, unfavorable market internals, and a preponderance of overextended syndromes, that prompts an interim comment.

Measured from the January 2022 market peak, the total return of the S&P 500 lagged behind the return of Treasury bills through April of this year. Meanwhile, our own measures of valuations and market internals have remained unfavorable. With the market seeming to skate by the trap door of extreme valuations and unfavorable internals without consequence, the push to new highs in the past few weeks has created the impression of a runaway advance.

As I noted in late-2021, there are certain features of valuation, investor psychology, and price behavior that tend to emerge when the fear of missing out becomes particularly extreme and the focus of speculation becomes particularly narrow. Last Friday, we hit a fresh “motherlode” of these conditions. Since the mid-1980’s, I’ve developed and collected scores of interesting syndromes and relationships that help to gauge overextended conditions, in both directions. I’ll occasionally add, discard, or tweak one or two, but for the most part, I’ve used the same set for years. The most important change in 2021 was to require deterioration in our gauge of market internals, regardless of how overextended conditions might be otherwise.