Cam Hui, CFA | cam@pennockideahub.com Page 1

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Trade Alert

BUY THE BREADTH THRUST AND FOMO STAMPEDE?

June 8, 2020

EXECUTIVE SUMMARY

Last week, technical analyst Walter Deemer pointed out that the market had flashed a

“breakaway momentum” buy signal. He did qualify the condition, “Supposed to get it near

the beginning of a powerful move, not after a 42% advance (although did have late signals

Jul. 12, 2016 and Nov. 20, 1950). Definitely not its finest moment...”

Could this be the start of a new bull leg? On one hand, the market’s animal spirits are stirring

and breadth thrusts like Deemer’s breakaway momentum signal have historically been

bullish. There are usually signals of a full-fledged Fear of Missing Out (FOMO) stampede,

especially in light of the surprisingly strong May Jobs Report. On the other hand, the market

is trading at a stratospheric forward P/E of 22.0 and at a 2021 P/E of 19.0. To buy now

means adopting the late 1990s go-go mentality that earnings don’t matter, and all that

matters is price momentum.

Careers are made and severely damaged during bubbles. Should you throw caution to the

wind?

The breakaway momentum and breadth thrust bullish thesis just doesn’t feel right. It is

difficult to reconcile a breadth thrust, which is built on the idea of a FOMO stampede by

investors jumping on a bullish bandwagon, with the observation of the lack of low quality

and zombie stock participation and extreme bullish sentiment. A FOMO stampede depends

on drawing in more traders who can pour money into the market, but the put/call ratio is

signaling a bullish sentiment extreme. In that case, where are the buyers?

Estimates of hedge fund positioning indicate that global macro and long/short hedge funds

are roughly neutrally positioned in equities and CTAs are in a crowded long. Fast money

retail traders are stampeding into the market, encouraged by the zero-commission regime

offered by online brokers. The analysis of the stock/bond ratio shows that it has returned

to above its 52-week moving average, indicating that a portfolio which did little or nothing

in reaction to the COVID-19 crash would have roughly the same asset allocation as pre-

crash levels. Therefore, there is no need to rebalance and little demand for equities from

long-term investors.

Consequently, it is difficult to buy into the breakaway momentum bull case. Our base-case

scenario calls for a corrective period to begin in the next few weeks. How the market

behaves after the correction is highly dependent on newsflow, but at a forward P/E of 22.4

and a 2021 P/E of 19.5 the market is priced for perfection. The bulls better pray that nothing

goes wrong.

Cam Hui, CFA cam@pennockideahub.com

Table of Contents

A Breakaway Momentum Buy Signal ....... 2

Analyzing Market Psychology with

Factors .................................................... 3

A Go-Go Melt-up Ahead? ........................ 9

Cam Hui, CFA | cam@pennockideahub.com Page 2

June 8, 2020

Trade Alert

A Breakaway Momentum Buy Signal

Last week, technical analyst Walter Deemer pointed out that the market had flashed a

“breakaway momentum” buy signal. He did qualify the condition, “Supposed to get it near the

beginning of a powerful move, not after a 42% advance (although did have late signals Jul. 12,

2016 and Nov. 20, 1950). Definitely not its finest moment...”

Exhibit 1: Breakaway Momentum Buy Signal

Source: Charter Trust Company

Could this be the start of a new bull leg? On one hand, the market’s animal spirits are stirring

and breadth thrusts like Deemer’s breakaway momentum signal have historically been bullish.

There are usually signals of a full-fledged Fear of Missing Out (FOMO) stampede, especially in

light of the surprisingly strong May Jobs Report. On the other hand, the market is trading at a

stratospheric forward P/E of 22.0 and at a 2021 P/E of 19.0. To buy now means adopting the

late 1990s go-go mentality that earnings don’t matter, and all that matters is price momentum.

Careers are made and severely damaged during bubbles. Here is how Jeremy Grantham

described the business risk he faced during past bubbles in the Q1 2020 GMO letter:

We exited Japan 100% in 1987 at 45x and watched it go to 65x (for a second, bigger than the U.S.) before

a downward readjustment of 30 years and counting. In early 1998 we fought the Tech bubble from 21x

(equal to the previous record high in 1929) to 35x before a 50% decline, losing many clients and then regaining

even more on the round trip. In 2007 we led our clients relatively painlessly through the housing bust.

Cam Hui, CFA | cam@pennockideahub.com Page 3

June 8, 2020

Trade Alert

Analyzing Market Psychology with Factors

To answer that question, we use factor analysis to delve into market psychology. The dot-com

bubble of the late 1990s was characterized by the frenzy of the belief in a new era. Earnings

didn’t matter, what mattered were eyeballs and addressable market for a product or service.

Low-quality stocks with negative earnings and cash flow outperformed high-quality stocks with

positive earnings and cash flows.

A similar effect can also be observed at the recessionary market bottoms. The shares of beaten

down nearly dead zombie companies stage a furious rally as they act like out-of-the-money call

options. We made a speculative call to buy the so-called Phoenix stocks a week before the

ultimate bottom in March 2009 (see Phoenix Rising?).

Exhibit 2: The Phoenix Buy Signal of February 2009

Source: StockCharts

An analysis of current factor rotation reveals an anomalous story of market psychology. As a

reminder, our primary tool is the Relative Rotation Graph (RRG). Relative Rotation Graphs,

or RRG charts, are a way of depicting the changes in leadership of different groups, such as

sectors, countries or regions, or market factors. The charts are organized into four quadrants.

The typical group rotation pattern occurs in a clockwise fashion. Leading groups (top right)

deteriorate to weakening groups (bottom right), which then rotate to lagging groups (bottom

left), which change to improving groups (top left), and finally complete the cycle by improving

to leading groups (top right) again.

Cam Hui, CFA | cam@pennockideahub.com Page 4

June 8, 2020

Trade Alert

Exhibit 3: Factor Relative Rotation Graph

Source: StockCharts

In light of the strong market rally, some factor returns were no surprises. Large-cap growth,

which were the FANG+ market leaders, is starting to falter. So was price momentum, which is

also dominated by FANG+ names. Up-and-coming leadership consisted of high beta and

small-cap stocks, though the emerging leadership of small-cap growth stocks is a minor

surprise.

Here is the bigger surprise. Why are the high-quality and shareholder yield factors performing

so well if Phoenix stocks would normally outpace the market in a recessionary rebound?

Cam Hui, CFA | cam@pennockideahub.com Page 5

June 8, 2020

Trade Alert

Exhibit 4: Returns to Quality and Shareholder Yield

Source: StockCharts

We can see a similar set of circumstances at play in small caps. The bottom panel shows the

now familiar small- to large-cap ratio (black line), indicating a small-cap revival. The Russell

2000 (RUT) to S&P 600 (SML) is a quality, or junk, factor at play within the small-cap universe.

The S&P 600 has a much stricter profitability criteria for index inclusion compared to the

Russell 2000, and the RUT/SML ratio therefore represents a small-cap junk factor. So why

were the small-cap junk stocks tanking on a relative basis since the market broke out through

its 61.8% retracement level since mid-May?

Cam Hui, CFA | cam@pennockideahub.com Page 6

June 8, 2020

Trade Alert

Exhibit 5: Small-Cap Quality Outperforming Since S&P 500 Mid-May Breakout

Source: StockCharts

Here is a long-term perspective of the small-cap junk, or low-quality, factor. Low-quality small

caps unsurprisingly lagged as the market fell from the dot-com market top, and turned up

coincidentally with the market at the 2002 bottom. Low-quality bottomed ahead of the market

bottom in 2008, and coincidentally with the market in 2016.

Cam Hui, CFA | cam@pennockideahub.com Page 7

June 8, 2020

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Exhibit 6: Long-Term Returns to the Small-Cap Quality Factor

Source: StockCharts

Recently, some anomalies have appeared. Low-quality bottomed in 2018 just as the stock

market topped out. We saw a second bottom in September 2019 just as the market began its

melt-up. From a strictly technician’s perspective, the combination of the latest parabolic rise of

this factor from September 2019, along with the stock market, could be interpreted as just a

sustained bull market. The COVID-19 crash and subsequent recovery was therefore just a

correction within a secular bull.

In that case, the S&P 500 point and figure upside target ranges from 3348 to 3779, depending

on how the analyst sets the parameters.

Cam Hui, CFA | cam@pennockideahub.com Page 8

June 8, 2020

Trade Alert

Exhibit 7: S&P 500 Weekly Point and Figure Chart

Source: StockCharts

Cam Hui, CFA | cam@pennockideahub.com Page 9

June 8, 2020

Trade Alert

A Go-Go Melt-up Ahead?

How realistic is the melt-up scenario?

The intermediate-term bull case depends on accepting the thesis of a go-go mentality as

manifested by the breakaway momentum signal. This breadth thrust is unusual inasmuch as it

was not accompanied by low-quality stock leadership that accompanied past recessionary equity

market rebounds.

In addition, sentiment is becoming frothy. The normalized equity-only put/call ratio is at a

crowded long extreme, which is contrarian bearish. Similar past reading, even during the dot-

com bubble era, resolved themselves with short-term pullbacks. None of the bullish sentiment

extremes coincided with breakaway momentum signals.

Exhibit 8: Normalized Equity-only Put/Call Ratio

Source: StockCharts

Helene Meisler wrote a RealMoney column analyzing the recent incidence of low put/call ratio

extremes: She concluded:

In the big picture, out of these six readings, four of them were part of a topping process. One gave you an

immediate plunge and nice rebound (2010) and one gave you a mild correction that then went on to rally for

months (2009). It's a matter of whether you think now is like August 2009, August 2010 or some other

time.

Cam Hui, CFA | cam@pennockideahub.com Page 10

June 8, 2020

Trade Alert

Another sign of excessive speculation is the spike in the ratio of Nasdaq to S&P 500 volume.

There have been reports of Robinhood traders buying low priced Nasdaq stocks, which is a

reason for the skew in this ratio.

Exhibit 9: Surging NASDAQ Volume = Rising Speculation

Source: Macro Charts

In conclusion, the breakaway momentum and breadth thrust bullish thesis just doesn’t feel

right. It is difficult to reconcile a breadth thrust, which is built on the idea of a FOMO stampede

by investors jumping on a bullish bandwagon, with the observation of the lack of low-quality

and zombie stock participation and extreme bullish sentiment. A FOMO stampede depends

on drawing in more traders who can pour money into the market, but the put/call ratio is

signaling a bullish sentiment extreme. In that case, where are the buyers?

Estimates of hedge fund positioning indicate that global macro and long/short hedge funds are

roughly neutrally positioned in equities, and CTAs are in a crowded long. Fast money retail

traders are stampeding into the market, encouraged by the zero-commission regime offered by

online brokers. The analysis of the stock/bond ratio shows that it has returned to above its 52-

week moving average, indicating that a portfolio which did little or nothing in reaction to the

COVID-19 crash would have roughly the same asset allocation as pre-crash levels. Therefore,

there is no need to rebalance into equities.

Cam Hui, CFA | cam@pennockideahub.com Page 11

June 8, 2020

Trade Alert

Exhibit 10: Stock/Bond Ratio

Source: StockCharts

Consequently, it is difficult to buy into the breakaway momentum bull case. Our base-case

scenario calls for a corrective period to begin in the next few weeks. How the market behaves

after the correction is highly dependent on newsflow, but at a forward P/E of 22.4 and a 2021

P/E of 19.5 the market is priced for perfection. The bulls better pray that nothing goes wrong.

Cam Hui, CFA | cam@pennockideahub.com Page 12

June 8, 2020

Trade Alert

Disclaimer

I, Cam Hui, certify that the views expressed in this commentary accurately reflect my personal views about the subject company (ies). I am

confident in my investment analysis skills, and I may buy or already own shares in those companies under discussion. I prepare and edit

every report published under my name. I depend on my colleagues for constructive criticism on my research methods and conclusions but

final responsibility is my own.

I also certify that I have not and will not be receiving direct or indirect compensation from the subject company(ies) in exchange for publishing

this commentary.

This investment analysis excludes any target price, and is not a recommendation to buy or sell a stock. It is intended to provide a means for

the author to share his experience and perspective exclusively for the benefit of the clients of Pennock Idea Hub (PIH). My articles may

contain statements and projections that are forward-looking in nature, and therefore subject to numerous risks, uncertainties, and

assumptions. The author does not assume any liability whatsoever for any direct or consequential loss arising from or relating to any use of

the information contained in this note.

This information contained in this commentary has been compiled from sources believed to be reliable but no representation or warranty,

express or implied, is made by the author or any other person as to its fairness, accuracy, completeness or correctness.

This article does not constitute an offer or solicitation in any jurisdiction.

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