I am of the opinion that the stock market still has some legs in this rally. As you can see in the chart below looking at month end numbers for the S&P, you can see a very similar co-movement between the current cycle (“the Great Recovery”) and the mid-70s bear market (“Oil Crisis”).
Note: “Great Recovery” till April 12, 2010, using monthly numbers. The Oil Crisis is from December 1974 – December 1976.
Clearly at Covert Analytics we espouse a cross asset class, global approach to investing. In other words the decision to invest in stocks is not only based on how risky the US market is, but also, how risky is it compared to other markets, how risky is it compared to bonds, etc. Clearly at this point in the cycle, with the S&P up over 70% (factoring in daily prices), it is hard to have an “all-in” approach to stocks. But I am still very optimistic at this point of the cycle, regardless of how much little upside is displayed by historical comparisons like mine above.
I do not think the market is likely to reverse direction. Clearly the tendency after a deep downturn has been to underestimate the efficacy of economic and monetary policy as well as the resilience of the business sector. It is very in vogue these days to speak of the new normal and how this means boring corporate profitability and a market with limited upside. What if everyone is wrong? What if we are facing a stronger than expected stock market environment?
If you look at historical stock market cycles, the average cyclical bear market has been followed by at least two years of positive returns. Of course we acknowledge that 2009 was a strong recovery year, and there are many risks out there. However, lets look at some market indicators to see how they are pricing in the recovery.
- Dr Copper / Oil are up sharply. Crude is only a couple percentage points away from its 52 week high, and Copper is signalling a very strong demand for the commodity.
- Yield curve is still very steep. Strongly positive sloping yield curves (steep) imply an upcoming economic recovery. The difference between the 10 year and 3 mo money market yields across the G7 are very high (353 bps in the US, 344 bps in the UK, 260 bps in Euro-zone, 327 bps in Canada, 322 bps in New Zealand, etc).
- Still low interest rates. Recent studies by Siegel have implied that low risk free rates encourage risk taking and thus higher multiples of earnings.
- Accomodative monetary policy. Federal Reserve bank is sitting tight at current levels, and so is the ECB / BoE / BoJ, etc. Only select commodity currency countries are in hiking mode (Australia).
- Junk spreads continue to compress. Single B spreads were 629 bps as of December 2009 and have compressed to 598 bps.
I guess our conclusion is the following, as long as short rates stay at zero, there is a high propensity for economic growth to accelerate, and for the stock market rally to continue.
Sincerely,
The Covert Analytics Team
