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Posts Tagged ‘stock market’

Keeping an eye on the indicators

Tuesday, May 18th, 2010

As we mentioned back here in our post on the direction of the stock market over the upcoming months, it is important to track the indicators.  Long story short, they have turned a bit ugly.  To paraphrase one of the true brightest and best:

“Put your ears to the railroad tracks. Prices move first, and fundamentals come second.”

This tells you that though reports are confirming that fundamentals are sound …

  • M&A, Capex, share buybacks, dividend increases have been running at historically low levels and are just beginning to rise
  • Corporates are lean, and richer in cash than they have been in decades
  • Profit margins are approaching all time highs, only a year after the “Great Recession”

… the market is sending a different signal:

  • Dr Copper and Dr Crude are both down about 17% (through today, May 18)
  • S&P was spooked into its largest intra day loss since 1987, and is now down about 7% from April 26
  • Yield curve (10s / 3Ms) has flattened by about 50 bps from nearly 380 bps to 330.

Where to from here? The Greek drama reflects a broader sovereign crisis that took us by surprise with respect to how quickly it cascaded into a crisis.  Greece was one of the weaker guys in the pack, but its amazing to us how Ireland has a deficit of -14.7%, compared with Greece’s deficit of -12.2% and little mention is made in the press of their situation. True, the total indebtedness of Greece is higher, at 124.9% of GDP compared with Ireland’s 82.9%.

And thats not all.  A massive oil spill, looming uncertainty over financial reform, civil lawsuits against the investment banks, etc.

Difficult times indeed. However we think the market is going to trade lower over the next few months. This is not to say the rally has been officially delayed, but these are major headwinds that have reminded the market that volatility is always around the corner. It is very easy to say that this has spooked a bunch of investors who have been cautiously adding to their exposure and are now reminded of the awful 2nd half of 2008.

Sincerely,

The Covert Analytics Team

 

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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 »

In the market today April 2, 2010 …

Thursday, April 1st, 2010

Nice continued move in the market today. I continue to believe that the economy is in a sweet spot where low rates continue to fuel economic activity, consumers are recovering, and businesses are eager to grow after 2 years in the trenches (doldrums). The S&P has edged up now for five straight weeks. Volume continues to be moderate.  This trend of higher prices on medium to low volume is healthy to me. It tells me that retail investors are not piling back into the market, which would be signs of a overly optimistic retail investor (ie signs of the end of the trend).

In fact, headlines are pointing out that the market is hitting an 18 month high (or about September 2008). Incredible isn’t it? In September 2008 before Lehman went under we were already undergoing a recession in the US, following the collapse of Bear Stearns, and putting up with a hectic seizure of the financial system. Unprecedented in many ways. Anyways, at that point the US market was still only 30% below its peak in November 2007.

Yields on US Treasuries are edging up. The US 10 year yield is hitting nearly 3.9%, which is  a relatively substantial selloff for the US Treasuries. It is likely there is more to come, but this is not the time. I think rates will rally from here and you will see the UST 10 at 3.5% within a few months.

Gold and Crude rallied really strong this week, with GLD hitting over $110 and Crude spiking to $85. Though historically speaking these are not outrageous levels, they are breakouts from recent ranges. This has clearly coincided with a selloff in the US Dollar (the EUR rallied to over $1.35).

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US Stock Market Outlook

Wednesday, January 27th, 2010
 
The S&P 500 today had a shakeout in response to the Federal Reserve announcement.  It has since made a great rally (not shown on the graph!!!).

S&P 500 Intraday

 Regardless of the noise today – please note the 5% correction we have had over the past two weeks. This coincided with earnings season.  It is interesting that 3/4 of the companies that have reported earnings beat estimates, according to Bloomberg.  If you look at an average 4Q earnings report, it is typical to see a 8-10% increase in revenue y-o-y but a nearly 20% gain in earnings.  Shows that companies are being run very efficiently; Gavekal says they are being run even more efficiently than sovereigns!

S&P 500 Intraday for past 15 days

The trend from March 2009 seems still well in place. It is clear the pace of stock gains has moderated since about November, and we are having another 5 % selloff. In the graph below there are arrows indicating the 5% corrections that have occurred since the rally began.  In other words, no need to cry wolf yet.  Markets are trading reasonably well and we believe they are in great shape.  In other words, any further weakness in the broad market would be seen as a short term buying opportunity for those investors who have not entered or have a lower than target allocation.

S7P 500 past 12 months

 

On a similar note, we acknowledge the many tailwinds that are facing investors … they include ( this is a non exclusive list compiled by us ):

  

And the case for the bulls is as follows:

Bulls ...

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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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