Equity investor seem to be in an optimistic mood, pushing stock prices ever higher. Only last week for instance the benchmark S&P 500 index breached key technical support levels, pushing past both the 20- and 200-day moving average.  Markets seem to have a tailwind helped in large part by the massive boost to global liquidity.

Yet as we’ve mentioned before in this blog, this surge has largely – though not exclusively – been powered by a relatively narrow slug of stocks, mainly in the US tech sector. SG’s bearish strategist Albert Edwards name checked the excellent Gerard Minack, last week who writes the Down-under Daily from Sydney. His new acronym combines the FAANGs (calling Google by its correct name Alphabet) with Microsoft to form the FAAANMs (Facebook, Apple, Alphabet, Amazon, Netflix & Microsoft). According to Albert, “Gerard notes the massive out performance of the S&P versus the MSCI rest of the world (RoW) is almost entirely attributable to the FAAANM, top 6 stocks”.

The chart below echo’s that message and is from last week is from analysts at DWS, a European asset manager. It demonstrates that the rally of the past three months has mainly been driven by those sectors already deemed to be pricey by conservative standards (when looking at price-to-earnings (P/E) ratios ), while the cheap ones continued to be avoided.

Last week though we saw a surge in many value stocks especially in the travel sector. Back in early March I bought a large slug of shares in Carnival and over the last weeks they’ve started rebounding aggressively. This wider market rally, with much closer correlations between sectors might be a sign that investors are becoming even more aggressively bullish. John Authers in his regular column for Bloomberg, Points of Return,  highlighted one sign of possible euphoria. He looked at Citi strategists and particularly Tobias Levkovich, the bank’s chief U.S. equity strategist, whohas been keeping a “Panic/Euphoria” index.

“This is based on rigorously quantitative and unchanging criteria all of which are rooted in market prices (the NYSE short interest ratio, margin debt, Nasdaq daily volume as a percentage of NYSE volume, a composite average of Investors Intelligence and the American Association of Individual Investors bullishness data, retail money funds, the put/call ratio, CRB futures index, gasoline prices and the ratio of price premiums in puts versus calls). It is a contrarian indicator. When the market is in panic, you should buy. In euphoria, you should sell.”

What might make this euphoria turn into despair ? Again, I have highlighted a long list of second to fourth order knock on impacts from the Covid crisis which might derail all this euphoria. And if one wanted to be simplistic one could even follow the dictum of selling in May and going away over the summer – not that that has worked in recent years.

A more likely bubble-burster in my book could be a nasty turn in tech sector profits. It makes sense that the big tech stocks would in relative terms sail through the first wave of the crisis but as the knock-on impacts cascade through the system, might this profits growth start to fade? Could Trump’s assault on Twitter be the first chink in the dam that could trigger a much bigger reversal in fortunes?

I’m not entirely convinced but let’s be honest, it has happened before. Back to Albert Edwards at SocGen – who is bearish as you can imagine about tech stocks, arguing that they may turn into cyclical sand. He reminds us that in the late 1990s

“..tech stocks had similarly enjoyed a period of massive outperformance that had hugely outstripped what was also a moderate outperformance of their eps relative to the market (see left-hand chart below). And just like recent times, what propelled US tech valuations to stratospherically high valuations back then was ample Fed liquidity and a bubble of belief. The 2001 recession exposed the tech sector as heavy with cyclical stocks masquerading as growth stocks. It was an easy mistake to make as the economic cycle had gone on for so long, and so many of the stocks were so young that they had never experienced a recession. Analysts could not easily distinguish the cyclical tech stocks from the growth tech stocks, especially as they too were intoxicated by ample Fed liquidity and a New Era frenzy. Analysts drank as much Kool-aid, if not more than investors – which clouded all rational judgment. Hence when the 2001 recession unfolded, many tech stocks suffered a totally unexpected fall in profits. These were not growth stocks at all and shouldn’t have been on 40x+ PEs. These were in reality cyclical stocks trading on peak multiples on peak cyclical earnings, when they should have been trading on top of the cycle, single-digit PEs”.