Nasdaq’s recent weakness signifies an important change in
market leadership that seldom happens without a strong reversal of overall
market direction as the market seeks new leaders. Nasdaq has now declined 7.3% since its peak
on March 6th while the S&P 500 is off 3.4% since its high on
April 4th. Moreover, the key
momentum stocks responsible for most of the previous strength in Nasdaq are
down much more. Since their respective
peaks Three D Systems is down 51%; FireEye 49%; Splunk 45%; Yelp 37%; Tableau
software 35%; Pandora 35%; and Workday 35%.
Others such as Tesla, Netflix, Facebook, Biogen and Gilead are also off
significantly. All of these stocks
either have no earnings or are selling at extremely high price/earnings
multiples. This is reminiscent of March
2000 when the dot-com bubble started to burst amid widespread investor denial
that the bull market could come to an end.
The probable change in leadership is also accompanied by
other indications that the long cyclical bull market may have ended. The number of new daily highs in the market
has diminished on each successive rally.
Margin debt is at record highs, both on an absolute basis and relative
to GDP. According to the Investor’s
Intelligence Survey, bearish sentiment is at the lowest level since 1987. Adding to the malaise, this is happening at a
time when the Fed has begun to pull back from its Quantitative Easing policy
that has boosted stocks in the last few years although the economy is still
staggering along at a tepid pace of growth.
Yesterday (Wednesday) the market overreacted on the
upside to the release of the Fed minutes of the March meeting on the grounds
that the FOMC appeared more dovish than originally thought. The ill-conceived
rally failed to hold up and for good reason. The Fed had already issued an explanatory
statement after the meeting followed by a Janet Yellen press conference. Nothing in the minutes changes the original
statement or comments at the press conference.
The statement indicated that interest rates would be kept low for some
time after QE ended. When Yellen was
pressed to state how long that might be she offhandedly said that it could be
six months, but was subject to the incoming data as are all Fed decisions.
To be sure, there was some question about the so-called
“dots” release, based on a survey of the Fed governors that indicated a very
slight rise in the fed funds rate one-to-three years out. The minutes show the FOMC discussing how to
explain this and avoid confusion, and that it did not mean a change in the
Fed’s policy. Furthermore, at her press
conference Yellen explained that the “dot” projections changed slightly from
time to time without necessarily indicating a change.
In sum, we think there has been a distinct change in
market leadership at a time when the Fed is tapering its QE program and
economic growth is inadequate. In our view this is part of a topping process
that is likely to result in a severe market decline.