Day traders have driven stock-market euphoria to an 18-year high, boosting the odds of a downturn in the next year to over 70%, Citi says
- Day traders have helped to drive stock-market euphoria to an 18-year high, raising the odds of a market downturn in the next year to over 70%, Citi strategists said last week.
- "These new participants have exploded arguably speculative buying which has goosed up the numbers of Nasdaq shares traded," which feeds into the strategists' Panic/Euphoria Model, they explained.
- They said that "short covering and near-term trader speculation are potentially creating the environment for the next accident."
- "People are ignoring joblessness, trade friction, social unrest, and risks that loom including possible COVID-19 reinfections, the end of bonus supplemental unemployment checks, and the upcoming elections," they added.
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The day-trading boom has helped to push stock-market euphoria to its highest level in 18 years, boosting the odds that the market will retreat within the next year, Citi's equity strategists said in a flurry of research notes dated Friday.
The bank's Panic/Euphoria Model recently recorded its highest euphoria reading since 2002, when the dot-com bubble was still deflating. The elevated level implies a 70%-plus probability of a down market in the next 12 months, Citi's chief US equity strategist, Tobias Levkovich, and his team said.
The surge in day traders on Robinhood and other platforms is partly responsible. One of the model's inputs, Nasdaq trading volume as a percentage of New York Stock Exchange volume, has been "particularly volatile and moved stratospherically," the strategists said.
"These new participants have exploded arguably speculative buying which has goosed up the numbers of Nasdaq shares traded," they added.
The euphoria also reflects retail money-market funds, put/call premiums, and the NYSE short-interest ratio, the strategists said. Their model's other components are margin debt, the put/call ratio, the Commodity Research Bureau futures index, gasoline prices, and a composite average of bullishness data.
'The next accident'
Levkovich and his team underscored several reasons to be concerned about the S&P 500, which has rallied more than 40% from its March low, to north of 3,200.
They highlighted lending-standards data pointing to pressure on industrial activity and earnings in the coming months. They added that company earnings would have to be "incredibly impressive" to support the benchmark index's current level.
"People are ignoring joblessness, trade friction, social unrest, and risks that loom including possible COVID-19 reinfections, the end of bonus supplemental unemployment checks, and the upcoming elections," they said.
"Short covering and near-term trader speculation are potentially creating the environment for the next accident, with retail volumes surging despite shocking unemployment."
The Citi strategists elaborated on their bearish view in the research notes.
They argued that the stock market's return to pre-pandemic levels assumes a coronavirus vaccine will be developed and swiftly distributed to tens of millions of people. They also detailed election risks such as a hike to corporate tax rates and stricter regulation if Joe Biden beats Donald Trump in November.
'Color us cautious'
Moreover, Levkovich and his team expressed skepticism about a V-shaped economic recovery.
While cost-cutting and efficiency drives during the pandemic might bolster corporate earnings, they could also lead to permanent job losses that constrain GDP, they said.
They added that consumption could also slow when enhanced unemployment benefits end in August, that employers might delay investing until they know the election result, and that bad data in the coming months could weigh on business trends.
"Color us cautious," the strategists concluded.