Alpha Power Investing Newsletter

July 1, 2020

Patience in the Face of Exuberance

Since bottoming out in late March 2020 the stock market has surprised most investors with a fairly relentless rally. While there has been decent breadth among some sectors, the bulk of the favorable action has been concentrated in the NASDAQ/Technology/Momentum/Growth segment of the market. Most everything else has taken a back seat. While this type of action can last indefinitely, historically when a market advance becomes overly concentrated in a specific area (think technology in 2000 and real estate in 2008), trouble typically follows.

In retrospect, the operative phrase since March is the old Wall Street adage which states, "Don't Fight the Fed." In other words, when the Fed is pumping money into the system and/or pushing interest rates lower, the market almost invariably reacts positively. At least for a period of time. We have seen a virtually unprecedented push on both counts by the Fed in recent months. The massive influx of cash into the monetary system and the extremely low level of interest rates convinced a lot of investors that the stock market is "the only game in town." Despite all of this we continue to warn investors to be cautious in the months ahead for a variety of reasons.

#1. Dow Election Year Seasonality
The black line in Figure 1 from the Stock Trader's Almanac highlights the average seasonal trend for the Dow Jones Industrial Average since 1950 during presidential election years. Note that there tends to be weakness into mid-March, strength into early August and serious trouble into late-October followed by a significant rally late in the year. Especially note the typically volatile performance contained in the blue box that includes late-June through late-October - i.e., the period we are entering now.

Given the vast uncertainty that currently surrounds the economy and the upcoming election in November, and given the potential for a better buying opportunity later in the year, we think investors should avoid the temptation to get too giddy regarding the recent advance.

#2. A Very Concentrated Rally
As mentioned earlier, another cause for concern is the "concentrated" nature of the current advance. Figure 2 - courtesy of - displays the NASDAQ 100 Index divided by the S&P 500 Index with the 14-month Relative Strength Index (RSI) of this ratio plotted in the bottom clip. The implication is pretty clear, as the last (and only) time this ratio (and the 14-month RSI) reached such an extreme level was in early 2000. Following that peak the NASDAQ 100 lost -83% of its value in roughly two years' time. Understand that we are by no means predicting a repeat of that debacle. But the chart does serve as a stark warning that the performance of the NASDAQ 100 Index is likely getting "overheated." Historically when something gets overheated, the subsequent "cooling down process" invariably involves sharply declining stock prices.

A similar sign of overheated concentration appears in Figure 3, courtesy of The chart displays the ratio between large-cap growth stocks and large-cap value stocks. Once again, the implication is pretty clear. While the lure of buying large-cap growth stocks seems fairly compelling at the moment, this chart reminds us that "when the worm turns" (and it always does eventually) it often happens very quickly and can involve a significant degree of volatility in the market. So again, we caution investors to avoid the temptation to "pile in".

#3. Valuations Remain Historically High
The final concern we will mention here (note that we have not even really factored in the outlook for the overall economy going forward - which remains very much of a looming question mark) is the fact that on a historical long-term basis the stock market remains extremely overvalued. In Figure 4 we see that the Shiller P/E Ratio (courtesy of stands at the extreme high end of its historical range. The only occasions when this P/E ratio has been higher was in 1929, 2000 and early 2020.

As always it is important to point out that valuation measures are NOT timing indicators but rather "perspective" indicators. Still, the current high reading serves as a sober reminder that whenever the next full-fledged bear market occurs, there is a tremendous amount of downside potential for stock prices - far more than most investors would even consider possible at the moment. To illustrate, simply note that for the Shiller P/E ratio to drop to the middle-of-the-road average of 15, the Dow would have to fall almost -50% from current levels.

As the stock market rises it naturally draws in more and more investors who fear "getting left behind." However, as you have seen, there are a number of compelling reasons to remain extremely cautious between now and late-October/early-November as that time period appears likely to offer a significant buying opportunity for patient investors - once some of the current seasonal/sentiment/economic/election concerns have been processed.

The lure of the stock market rises with each up day. But the risks in the months ahead remain high. In the meantime, please note that the maximum drawdown for intermediate-term treasury bonds during June through October since 1981 has been just -2.5%.

Jay Kaeppel
Director of Research

Disclosures and Disclaimers: Past performance is not a guarantee of future performance. The returns illustrated in the charts above do not represent actual trading and are not representative of the returns of any strategy. The illustrations are designed to quantify the effect of certain time periods on the Dow Jones Industrial Average, S&P 500, NASDAQ 100 and Russell 1000 as specified. Indexes are not investment vehicles and persons cannot invest directly in an index. Index funds and ETFs may vary somewhat from index returns due to management fees and portfolio structure. The data used to construct the illustrations were obtained from third-party sources. While Alpha believes the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.

The information contained herein does not constitute and should not be construed as investment advice, an offering of investment advisory services, or an offer to sell or a solicitation to buy any security. Before investing in any fund and/or strategy, investors should consider the investment objectives, risks, charges and expenses of the fund/strategy and its investment options.

Alpha Investment Management, Inc. is a SEC registered investment advisor located in the State of Ohio. Such registration does not imply a certain skill or training and no inference to the contrary should be made. The information and opinions expressed in this document are for informational purposes only. Any recommendation or opinion made in this document may not be suitable for all investors. The information contained herein does not constitute and should not be construed as investment advice, an offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

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