Low Cash Levels And Low Expected Returns?

The continued legal battles over the election and worsening spread of COVID-19 cases weighed on stock prices for most of the week. Adding to the uncertainty last week was the question on everyone’s minds: to travel and visit family for Thanksgiving, or stay home? This dilemma is taking priority for many investors over the question of establishing new positions in stocks.

Therefore, it was not surprising that the S&P 500 drifted lower as the week progressed, as shown by the hourly chart above. The heaviest selling came late Wednesday and early Thursday, but the volume spike in the last hour Friday on selling is also a potential concern going into the week ahead.

Despite the downward trading last week, it is somewhat encouraging that the S&P 500 is just 1.91% below its record close. For the week, the iShares Russell 2000 (IWM)
was the strongest, up 2.3%. It was followed by a 1.2% gain in the Dow Jones Transportation Average led by the airline stocks, as encouraging news from Moderna (MRNA) about their vaccine helped spur hopes that normal levels of air travel would resume.

The Dow Jones Utility Average was the weakest, down 4.1%, giving up more than the 3.3% it gained the prior week. The other major averages showed minor losses for the week but all are now higher year-to-date (YTD).

The latest survey of 190 fund managers from the Bank of America
analysis revealed that “investor optimism surged this month to its highest point since January 2018”. It was also reported that cash levels dropped to 4.1%, which is a similar level to that seen in January 2020.

This follows on last week’s discussion of the sharp rise in the percentage of investors who are bullish in the American Association of Individual Investors’ (AAII) weekly survey, which then stood at 55.8%. That was also the highest reading since January 2018. This bullishness is worth noting, as periods of high bullishness often precede corrections or negative trend changes.

However, in this past week’s survey, the investors turned more cautious. As of the November 18 survey, the bullish% dropped 11.5 points to 44.4%, while the percentage of those with neutral outlooks rose 10 points to 29.3%. There was little change in the bearish%. There seems to be a growing consensus that the economy will be better in 2021, but several investment banks expressed their concerns that GDP could be negative in the first quarter. Official data on the quarter will not be released until April 29, 2021.

Long term capital returns were in also in focus last week, as JPMorgan’s
chief global strategist announced that a 60% global stock and 40% US Bond portfolio was projected “to provide an annual return of just 4.2% over the next 10 to 15 years”. That is down sharply from the compound annual growth rate of 10.2% since 1980.

The low future projection is due in a large part to the bond portion of the 60/40 portfolio. The US 30 Year T-Bond had an average yield of 11.27% in 1980, and currently yields just 1.52%. This low yield rate limits the potential gain of the bond portion of the portfolio. When yields go down, bond prices go up, and there’s not much more room for yields to go down.

The signs of both professional and individual investor exuberance, although worth watching, do not alter the positive technical outlook as we head into 2021. Over the near term these sentiment readings do, however, increase the chances of a sharp correction before the end of the year.

The daily chart of the Spyder Trust (SPY)
shows the slight pullback from the spike high (see arrow) that coincided with the news of the Pfizer
vaccine. The completion of the flag formation (lines a and b) indicates an eventual move to the $380-$390 area.

There is initial support at $350, which is not far below current levels. The stronger support at $340 is 4% below Friday’s close. It would take a move below the September low at $319.80 to turn the chart negative.

The daily S&P 500 advance/decline line made a new high on Monday, but then turned lower. It has almost reached its rising weighted moving average. The more important converging support (lines c and d) could be tested on a further correction.

Of course, the market may instead surge higher in the coming holiday-shortened week. This would likely just postpone a sharp correction. Such a correction would help reduce the too-high bullish sentiment, and take many markets back to good support where the risk on new long positions is more favorable. The fact that the IWM and NYSE Composite are less than 3% below their weekly starc+ bands is another indication that the risk has increased

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