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Investor Overconfidence Could Lead to ‘Melt-Up’ And Crash Like ‘99

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Investor Overconfidence Could Lead to ‘Melt-Up’ And Crash Like ‘99

Stocks, bonds, and commodities continue to head toward a fourth straight month of rising prices. With this, overconfidence among investors has become a worrying sign that the market could be near a top.

Through late last week, both the S&P 500 and the S&P GSCI commodities index were up 25% since the March lows, and the Bloomberg Barclays US Aggregate Bond Index was up 3% since late March.

If the three indices can hang on to those gains through the end of this month, it will be the biggest simultaneous four-month gain for the indices going back to 1976.

This surge in stock prices has created a whole new class of market participants. These participants are people who buy stocks simply because the price keeps going up.

This “melt-up” in prices is a worrying trend.  New investors don’t have an understanding of economic fundamentals or market dynamics. They could also easily get caught if and when the tide eventually goes out. Right now, however, they are riding the “fear of missing out” to pile into everything from large tech stocks like Apple, to electric car maker Tesla to precious metals like gold and silver.

The simultaneous rise in the price of stocks and “safe havens” assets like gold and silver has caught many by surprise.

Christopher Stanton, chief investment officer of Sunrise Capital Partners, says that it could be investors who are riding momentum stocks as far as they can, but also adding a safety net like gold to their portfolio to be ready for the eventual collapse.

“People are hopping on the train, and they’re also looking to get anything else in their portfolio for when the day of reckoning comes,” says Stanton.

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“In 90 days, all of a sudden, we could run into a brick wall,” he added, saying that the November election could dump cold water in the stock market if a Biden victory means higher corporate taxes.

Also worrisome for analysts is that a majority of gains since March have come from a small group of tech stocks. These include those from Apple, Google’s parent company Alphabet, Facebook, and Amazon. All of these companies will report their earnings this week. Any bad news could send markets plunging.

Investor overconfidence in high-flying stocks like electric car maker Tesla could also point to a market top.

The stock climbed more than 350% since the March lows. Since many have gained overconfidence, many new investors piled into the stock. Now, it has become one of the most widely-held stocks on Robinhood.

“For a lot of people, it’s hard to look at a stock like [Tesla] that goes up and up and up and not feel like you’re missing out,” said Victoria Fernandez, chief market strategist at Crossmark Global Investments.

That momentum, however, also works in the other direction. Since the company announced earnings last week, the stock has slipped 13%.

But let’s worry about a correction some other day. For now, let’s party like it’s 1999.

“There are striking similarities between investors’ behavior around the millennium change and today. Speculative positioning on the back of extremely optimistic expectations channeled liquidity into the equity market. Investors piled into the tech sector as the first chart above reveals. Meanwhile, eight out of ten key industries flatlined during the same period in terms of fund flows. Digging deeper into the tech sector reveals that not even 50% of its components trade above their 200DMA. The buying is concentrated on very few stocks. A sign that investors are overconfident and pick their darlings among a few stocks from the FAANG+ group.”

“Investors are partying like it’s 1999. Valuations don’t matter, trends get extrapolated, and the Fed put is part of almost all bullish narratives.”

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