So many people wonder, can this rally be trusted? Is the pause we got midday today the real deal, or is it a momentary pitstop on the way to much higher levels as we saw by the end of the session. More important, could we now challenge the old highs from January?
I find the whole line of inquiry about the reality of the market's climb to be fatuous. It stems from a belief that all selloffs are true, realistic and trusted, but all rallies are suspect. Even today, when the market came down, we heard that after seven days we saw its true colors. When the market was going higher, we knew that it had to collapse because things just aren't good enough to justify the run.
Why is there such a double-standard? Why do selloffs have instant credibility and advances are to be doubted?
First, let's address this current moment and analyze how we got up this high, and then we can scrutinize the bear case and why it carries so much weight in the media versus the bull case.
Until today we have seven straight days of rally. I see five reasons why the rally actually had gravitas.
First, we had just come through the bulk of earnings season and the vast majority of companies reported better than expected sales and earnings AND raised forecasts. As I never tire of telling you, the best predictor of a stock's direction is whether it beats the consensus estimates of what the company is supposed to report. Now I think there is a lot of cynicism about the estimates but I can tell you that analysts actually do their best to come up with these estimates. In fact, much of the conference call questioning is about modeling the next quarter and the year. So if a company truly does beat the numbers and tells analysts to raise their forecasts it is a big deal and has to be trusted.
Second? When we look at the earnings en masse for the quarter so far we have to conclude that they are substantially better than we thought. That means what we are paying for earnings may have looked expensive before the quarter but it isn't expensive now. We put these judgments in the form of the price to earnings multiple of the entire market. When we came into the year, stocks were selling at 18 times earnings. Now they are selling at 16 times earnings. Eighteen times earnings is a little expensive. Sixteen is pretty cheap although I have seen it as low as 12 and 14 times earnings after gigantic selloffs. That valuation, however, does make it harder for stocks to get hammered.
Third, we keep hearing about all of these buybacks and I totally get it. There are plenty of companies using excess capital to buy stock. I don't find this nearly the driver that so many think it is because to me most buybacks are pretty lame. A little bit of stock is being bought each day, not enough to make a difference. Nor is there much difference in earnings unless a company buys back more than 5% a quarter. The best buyback I know right now is the Citigroup (C) buy back: 7% of its stock each year. Yet the stock has lagged behind some of its biggest competitors which are buying back far more stock. Still I get it, buybacks can be tabulated and they are tangible tokens of credibility.
Fourth, takeovers have become a staple and the deals are huge, the largest on record year to day. Consider the multi-billion dollar deals we've see, deals like T-Mobile's (TMUS) bid to buy Sprint (S) , or Marathon Petroleum's (MPC) purchase of Andeavor (ANDV) , or Broadcom's (AVGO) attempt to buy Qualcomm (QCOM) or Qualcomm's deal for NXP (NXPI) , a deal which looked like it was going to be quashed by the Chinese authorities. These matter, not just because they take stock out of the equation, something that's very needed given all of the initial public offerings we have seen, but because they tell you that stocks might be cheaper than you think.
Finally, fifth, so many people were negative going into this season, in part because of worries about valuations versus the ten year Treasury but also because of fears about trade wars. Lots of this rally may actually be traced to hedge fund managers who were short ETFs that encompassed FANG and had to cover or the S&P 500 itself which can, indeed, be moved by the needs of managers to close out their shorts or get long instantly to show their clients that they weren't on the wrong side of the ledger.
Okay, now, given those pretty darned substantive reasons for the advance - with the least credible in my eyes, the buybacks, being the most accepted - how can pundits and money managers still ponder the question of the reality of the rally?
I think that there's a twisted tale why and I will go over the reasoning in its sum total and then unpack it. There are plenty of managers who think the market should never rally because stocks go up on hype and hope but go down on reality, a narrative that is well understood by the media.
Look I totally get this. Today, this morning, on our own network Ron Baron, a very good money manager, announced that he expects to make "twenty times our money on Tesla (TSLA) ." I found this statement very painful. Why? Multiple reasons. One is that we know this company loses money hand over fist. Two, we know that its CEO Elon Musk has constantly talked a big game and not backed it up with the production numbers needed to hit his projections. Three, high level execs keep leaving the company - two just left in the last 72 hours. High level departures would matter tremendously at any other company. How can we give this one a free pass? Finally even the bulls on the sell side of Wall Street accept that the company might have to raise money, something that Musk is adamant about not needing.
All of these reasons make me suspicious of the company. But here's a respected manager telling you not that he expects that the stock will go higher, not that he thinks it can advance 20%, nor that it can double or even triple or go up 10 times. No, it's going up 20 times, which would make it the first trillion dollar company.
Quite frankly, I find that prediction to be the kind of hype that I can't get comfortable with. That's a level of surety that makes you want to buy it knowing that if it goes down big you just keep buying it because it is going to end up at 20 times its current value. That's the kind of promotion that makes people feel that the stock market is a bunch of hooey and the rally just totally fraudulent.
We also know at any given moment there are companies that seem to be so expensive because they have gone up so much that they strain credulity. How do they strain it? Quite simply because when we get a selloff it is much more harsh and violent than any time stocks move up. Today, for example, the cloud kings dropped gobs of points after rallying pretty consistently for weeks on end. The selloff was far more dramatic than the advance .
So the combination of those who do hype and the vicious nature of the selloffs make you think you know what, it is a bit of a fraud even if the overall market is not historically expensive.
Here's how I come out: I hate the hype but I recognize that a virulent angry decline can wipe out so much money so quickly that people want to try to avoid the selloffs far more than they want to catch the advances. I think that they should be symmetrical in their judgments and just because the losses are so quick versus the advances doesn't mean we should sniff so heavily at the rallies. Therefore I would like the questioning of a decline to be equal, especially given that the multi-year gains should give advances not declines the benefit of the doubt.
