Stocktake: Stocks pause for breath after big rally

Stocks did something rare last week – they fell. Some kind of pause was overdue, given that the S&P 500 had jumped 8 per cent in seven weeks and technical indicators had hit their most overbought level since January 2018’s market top. It’s been almost too easy lately. Stocks had gone 30 consecutive trading days without a back-to-back decline.

That represented the longest streak since March 2005, says Bespoke Investment, which notes you have to go all the way back to the 1950s to find other comparable episodes. Similarly, the index had closed above its short-term 10-day moving average for 29 consecutive days.

This combination of continually avoiding back-to-back declines and closing above the 10-day average has only been seen once in the history of the index, in 1955. Meanwhile, there hasn't been a whiff of volatility. The difference between the S&P 500's daily high and daily low hasn't exceeded 1 per cent since early October, notes Ryan Detrick of LPL Research, making the last few weeks "one of the least volatile, yet persistently bullish periods we've ever seen".

What goes up doesn’t have to come down, of course. Still, after such a strong run, investors can hardly complain if stocks take a breather in advance of the seasonally strong Christmas period.

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Tech stocks begin to look pricey

This year's market rally has been led by technology stocks, with the two biggest – trillionaire stocks Apple and Microsoft – leading the way with gains of 67 and 47 per cent, respectively. That said, the tech sector gains have not been driven solely by large-cap giants; almost everyone is doing well this year, with the information technology sector up 40 per cent, handily outpacing the S&P 500's 24 per cent gain.

The gains have come even in the face of poor earnings. FactSet data shows IT sector earnings declined 5.3 per cent in the third quarter, the third-largest decline of the S&P 500’s 11 sectors. As a result, the tech sector now trades on 21 times forward earnings, notes FactSet, compared to 18 for the S&P 500.

Tech stocks tend to trade at a premium to the broader market so the differential is hardly alarming, but valuations have crept up to levels that are elevated relative to history.

At the start of this year, tech stocks traded on 16 times trailing earnings, notes Bespoke Investment, compared to almost 25 today. That’s higher than more than 99 per cent of readings over the last decade, says Bespoke.

Valuations are nowhere near bubble levels – they would need to triple to reach their 1999 peak, notes Bespoke – but it’s clear tech stocks will need to deliver strong earnings next year in order to satisfy investors’ increasingly high expectations.

Epic fall for world’s best-performing stock

Market bubbles usually deflate over time, but not in the case of Hong Kong marble producer ArtGo. Having gained 3,800 per cent this year, the world's best-performing stock lost 98 per cent of its value last Thursday after index provider MSCI reversed its decision to include the company in its China index.

MSCI had announced ArtGo’s planned inclusion just two weeks earlier before announcing a U-turn following “further analysis and feedback from market participants on investability”. That’s presumably a reference to activist investor David Webb among others, who has been warning for months that this was a dangerous bubble.

Prior to the crash, ArtGo was trading on 85 times sales, even though revenues had halved in the first half of the year. It was valued at 46 billion Hong Kong dollars, or €5.3 billion. By Wednesday’s close, it was worth HK$688 million, or €79 million. Insane gains followed by sudden collapses are disturbingly common in Hong Kong. Index providers like MSCI ordinarily focus solely on quantitative factors like market capitalisation and liquidity when considering stocks for inclusion.

That’s fine in efficient and transparent markets, but not in Hong Kong, where the dangers of what David Webb calls a “mindless index” are all too apparent.

Analysts underestimate humble CEOs

High-profile chief executives like Elon Musk dominate the headlines but investors may be better off seeking out more humble CEOs. That's according to a new study, The Case for Humble Expectations: CEO Humility and Market Performance, which finds that companies led by humble CEOs deliver better stock market returns.

The study, which gauged humility by analysing videos of 185 CEOs of S&P 500 companies, found humble CEOs don’t actually perform better. Rather, they benefit from an “expectation discount”. Analysts underestimate them and have lower earnings expectations for firms led by humble CEOs. That sets the stage for them to more easily beat or meet earnings estimates and a nice earnings pop.

CEOs should manage their humility because too much humility can lead to them being unfairly perceived as weak, said study co-author Prof Oleg Petrenko. “But a little humility can help you manage the expectations and set yourself up for exceeding them.”