‘Extremes are becoming ever more extreme’: A Wall Street strategist who sounded the alarm before last year’s 35% crash showcases the evidence that a similar meltdown is looming
- Market strategist Sven Henrich, who warned of the crash before it occurred in February 2020, says "we are staring at the largest valuations and technical disconnects ever."
- He said the difference between current price levels and exponential moving averages shows stocks are again due for a pullback.
- Visit Business Insider's homepage for more stories.
On February 20 last year, right at the market's top, Sven Henrich reiterated a warning.
"From my perch this market is the most dangerous we've seen since 2000," Henrich, the founder of NorthmanTrader, wrote in a post on his site.
Over the course of the following month, the market would go on to shed 35% of its value as the global pandemic worsened.
Now, almost a year later, Henrich is prophesying again. And he's not mincing words.
"I feel like I'm repeating the same exercise again," he wrote in a post on Tuesday, adding, "we are staring at the largest valuations and technical disconnects ever."
Henrich — well known for his technical analysis, or observations made from trends in price action — is basing his argument on the exponential moving average (EMA) metric, which calculates a moving average by placing more emphasis on the most recent price points rather than equally weighting all data points in the calculation.
He laid out a few charts showing the disconnect between the different indices' current price levels and their EMAs for different time frames. He said prices are at one point or another bound to revert to their EMAs, adding that such moves can be "violent."
Here's the disconnect between the S&P 500's current price levels and its yearly 5EMA, or exponential moving average of its price levels for the last five years. It's represented by the blue line.
And here's the Nasdaq's current disconnect from its five-year EMA.
Here's the Nasdaq's EMA for the last five quarters. The top of this chart also shows negative divergence in the Nasdaq's relative strength index, or RSI. While the index's level is hitting an all-time-high, it's considered overbought and overextended.
"Indeed the technical stretches are so vast they themselves are screaming danger as the charts are practically begging for rebalancing and reconnects," Henrich said in the post.
In an interview with Insider on Tuesday, Henrich expanded on these sentiments, lambasting the Federal Reserve's role in inflating asset prices.
"My concern generally is just that they've created the biggest asset bubble in history," he said. "Market cap to GDP is 190%, which is absurd."
"It's at the levels of 2007-2008. S&P market cap to GDP is the same as it was in 2000 during the tech bubble," he continued. "Typically not where you start a recovery from."
Henrich's criticism isn't only limited to bigger indices, which are driven by mega-cap tech stocks. He's also concerned about the steep price appreciation in small-cap stocks in recent weeks.
Since election day, the Russell 2000 index has risen 32%.
As for potential catalysts that could send stocks plummeting, Henrich pointed to a rise in the value of the US Dollar or a steepening yield curve as two prime culprits. Both trends could kick in as the economy recovers from the recession.
Growing calls of a bubble
Henrich isn't alone in his concern about a bubble developing.
Though just about every major Wall Street institution predicts the S&P 500 will rise in 2021 amid an anticipated economic rebound, calls for caution are growing just two weeks into the new year.
For one, Bank of America's Chief US Equity Strategist Michael Hartnett said in a January 7 note that investors are rationalizing "increasingly irrational price action."
A recent E*Trade survey also found that 66% of investors believe stocks are in some sort of bubble.
And Morgan Stanley's top strategist Mike Wilson said earlier this week that stocks are due for a period of underperformance.
Still, it remains unclear what the market's trajectory will be in the months ahead. Bullish investors argue that easy financial conditions and a presumed recovery this year justify valuations.
JPMorgan analyst Marko Kolanovic said in a January 14 note that investors should remain in stocks for these reasons.
"We expect 2021 to deliver the strongest year of global GDP growth in over two decades as mass vaccination permanently severs the link between the COVID-19 virus and economic activity," Kolanovic wrote in the note.
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