2021 is starting to look like 2000, according to some strategists.
Between a retail trading frenzy, euphoric sentiment and stretched valuations, the markets today are looking increasingly similar to those during the dot-com bubble, Bank of America strategists wrote in a note Monday. The run-up in shares of GameStop (GME), AMC (AMC), Express (EXPR) and other names last week strengthened that analogy, as droves of traders piled into heavily shorted stocks at the encouragement of peers on Reddit, they noted.
“Last week’s sell-off (the worst since October) was likely catalyzed by a retail-led short squeeze, but similarities to 2000 extend beyond heavy retail participation,” Bank of America equity strategist Savita Subramanian wrote in a note on Monday. “We also see similarly euphoric sentiment... rich valuations, and no rewards — in fact negative alpha — for this earnings season.”
According to Bank of America, the recent rise in euphoria serves as a contrarian indicator of a possible pull-back, following unsustainable frothiness in the stock market. Bank of America’s proprietary Sell Side Indicator, which measures Wall Street strategists’ bullishness on stocks, increased by nearly 1 percentage point in January to 58.4%, from 57.8%.
“The indicator still remains in ‘Neutral’ territory where it has been since December 2016 and is in an environment where returns are less predictable compared to when the indicator resides between ‘Buy’ and ‘Sell’ thresholds,” Subramanian said. “But the current level is now less than 2 [percentage points] away from a ‘Sell’ signal, the shortest distance to ‘Sell’ since August 2007 after which we saw 12-month returns of -11%.”
To Bank of America’s third point, rich valuations have also raised concerns of a correction, as the S&P 500 continued to march higher despite earnings declines in each of the last three quarters. The index was trading at a forward 12-month price-to-earnings (P/E) ratio of 21.8 as of Friday, according to FactSet data, or well above both its five-year average of 17.6 and 10-year average of 15.8, largely due to a surge in prices of growth stocks.
“Valuation dispersion in 2000 was similarly stretched, and our work indicates downside risk based on dispersion today: If P/E multiples snapped back to average, all else equal, we could see close to 10% downside to stocks,” Subramanian said.
Finally, the lackluster performance of stocks despite better-than-expected quarterly earnings results also closely mirrors the price behavior from around the dot-com bubble, Bank of America noted. More than 180 S&P 500 companies have so far reported fourth-quarter earnings, and have beaten consensus expectations by an average of 10%. Still, the S&P 500 slid more than 3% in January, as companies’ stronger than anticipated results still failed to stoke more buying.
“Companies that beat on both sales and EPS [earnings per share] underperformed by 50 bps [basis points] the following day, the worst in history,” Subramanian wrote. “The last time we saw similarly perverse reactions was at the peak of the tech bubble, ahead of which the market declined by 13%.”
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Emily McCormick is a reporter for Yahoo Finance. Follow her on Twitter: @emily_mcck
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