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Posts Tagged ‘SPX’

Speculation on Future Stock Market Direction

Monday, April 12th, 2010

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

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Posted in Business Cycle, Stocks | 2 Comments »

Stocks and the US$: Correlation Update

Tuesday, March 23rd, 2010
 

First lets review the formula. 

A correlation between two variables is the covariance between each divided by the product of each variables standard deviation (or the square root of each variables variance).

Since the correlation is a normalized number it is important to remember that it is a user friendly but not that usable variable. It describes the co-movement but says little more than that. There are much more powerful analytical co-dependence functions than correlation. Product advertisement: we are thinking about developing a powerful yet fun to use platform that will facilitate statistical modelling of financial markets.

Anyways, look at the recent rolling correlation of the S&P 500 and the US dollar.  This is a rolling 1 year correlation using weekly percent return figures on SPX and DXY.

S&P 500 and DXY Correlation: (Weekly, 1 year)

  1. Notice the very positive correlation leading up to the Tech bubble market peak in early 2000, where the correlation was as high as 60%.  Here the US economy was booming, the stock market was in a dizzying rally, and the US$ continued to strengthen (the EUR was at $0.85 in 2000, versus $1.35 now).
  2. The average correlation in this period was -20% as a strong dollar usually meant bad news for the US economy as it hurt exports, and correspondingly the market. Leading up to August 2008, the equity market was correcting and the equity market was selling off until September when Lehman went broke, and there was a massive flight to quality and the US$ rallied. This threw the market’s negative correlation back to nearly all time low of -60% until …
  3. From less correlated to slightly less correlated.  The correlation is increasing. We had a substantial bottom in the Dollar in December 2009 (since then the DXY is up nearly 8% and SPX is up about 6%).

It is important to mention that though the trade weighted Dollar is up 8% since early December, it is up almost 11% versus the EUR. This implies that versus other currencies the USD has not gained much.

Thanks for reading,

The Covert Analytics Team

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Posted in Foreign Exchange, Market Talk | No Comments »

Valuing Mr. Market

Tuesday, March 9th, 2010
This table gives a good snapshot of how a wide range of global, developed stock markets have performed since the US bottomed exactly 1 year ago.   The US is up 68%.  However on a fundamental metrics basis, the US is trading at 12x future earnings, compared with 10-11x in Germany / France / UK. Note also that these European markets have a higher dividend yield of almost 150 bps.

Global Equity Snapshot

 

 Here is where the S&P stands now, both on its EPS (Earnings per share) and the P/E multiple (Price divided by Earnings).  This gives us the current value of about 1,135 on the S&P.  

  

Now, where to from here? Assuming bottom up company forecasts of about $78 of an EPS number for this calendar year (thus an estimate), let’s see how this calculates through for a range on the S&P.  Jeremy Siegel recently was quoted as saying that in this range of a low real interest rates environment, a P/E multiple of approximately 18x fits.  That would give us a decent amount of upside still in the Equity market. 

 

The first table was taken from a Barron’s article, “Happy Anniversary, Investors” commetning on the 1 year anniversary of the stock market bottom (3/9/2009). Basically the conclusion is that there are still a plethora of good investment options, and though they are not outright giveaways.  Here is a summary of some “giveaways” from last year: 

Ford (F) at $2, now at $12
General Electric (GE) at $6, now at $16 
Goldman Sachs (GS) at $53, now at $171 

Anyways, in conclusion: there are solid investments out there, for buyers with patience.

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Peaks and troughs in the Chinese stock market

Thursday, January 14th, 2010
 

We wanted to evaluate the peaks and troughs in the Chinese Shanghai A share stock index and see how they compared with the US benchmark (S&P 500).  The Shanghai index defines how a “high octane” market performs.  What we did was look at all the major peaks and troughs in the SHASHR index and see for the exact same period how the US market performed.  We were surprised by the results. 

Keep in mind that what occurred during the past 15 years (pay attention to timing):

  1. On a total return basis the US equity market had no negative returning years in the 90s.  The Shanghai market on a calendar year basis was down -21% in 1994 and -14$ in 1995.  The major bottom however occurred in July 1994. 
  2. The LTCM crisis and Russia default in 1998 was a blip on the screen in the long term bull market of this period.
  3. The US officially entered into recession in 2001, but the TMT bubble burst in March 2000.  After declining nearly 50% the US equity market bottomed out in March 2003 (October 2002 had a false bottom!) and began a multi year bull market till the end of 2007. 
  4. The financial crisis was a multi year event but most major Equity markets peaked in October 2007.  The US equity market had a false bottom in late 2008 then had a mini rally til the lows were retested in March 2009 (where the major bottom was formed).

China versus the US (local currency) The first major market correction from 2001 through 2005 coincidede with a positive return in the US market. The next bull market run from 2005-2007 in Shanghai was met with a modest +30% return in the US market - note it already had a huge runup. The financial crisis and subsequent market recovery showed a very similar tune. Taking a step back for a second, we wondered how Brazil performed during these times: Brazil, US and China ..... local currency

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Posted in Business Cycle, Market Talk, Stocks | No Comments »

Market Technicals

Wednesday, January 13th, 2010

One of the best contrarian indicators we know of is the % deviation from the 200 day moving average.  Its intuitive and reliable.  The simple explanation is as follows: an extreme deviation from the moving average signals an over bought or over sold condition. 

% deviation - measure the shaded area!

Many people look simply at whether the current price is moving above or below the moving average.  But in a low volatile environment by default the price indexes will essentially hug the moving average and thus provide little insight.  At market extremes however you will see a strong deviation from the moving average.

Current indicator readings

Its clear that the EM countries are indicating some frothiness.  Brazil is up 139% since its lows in March … this bull market is well advanced and it seems that adding money to EM is a bit “after the fact” performance chasing and is not a good place to bet your portfolio dollars.

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Posted in Market Talk, Stocks | No Comments »