Some 5 years and 1 day after hitting the devils number itself of 666, the benchmark global and U.S. index, the S&P 500, has now almost tripled in price and in the process delivering one of the strongest equity bull markets on record, certainly over the timescale in question. This is all the more impressive as at the nadirs of the GFC and the bear market, the market’s valuation had not reached the price to book and PE floors of previous mega bears just after the Great Depression and during the stagflation era of the 70’s.
As the U.S housing bubble got ever more stretched during the mid-noughties, gravity and economic reality was finally asserted with global markets imploding in 2008 and equities in particular being severely punished with the S&P 500 losing a whopping 57% of its value between October 2007 and March 2009. If the downtrend was energetic, the current bull market not only obfuscates it but also pushes the past into oblivion as the S&P 500 has moved to ever more new record highs. With the last bull market lasting from October 10, 2002 through to October 11, 2007, or exactly 5 years and 1 day, the next few sessions will be psychologically important…
Let’s take a look at the fundamentals behind the market to try to understand the current bull markets dynamics.
The present run has been very strong with the S&P 500 gaining almost 180% in 5 years. Markets around the globe have been rising for the last five years but the pace of growth has been particularly strong in the US with all the main indices showing epic rises. A brave investor at the floor in 2009 in technology equities would today be around 3.5x richer as the Nasdaq 100 has recorded one of the strongest rises out of all the benchmark indices – some 250%. Still, even for those more averse to risk, the “traditional economy” as represented by the Dow, rose a fantastic 150%.
Consumer Discretionary, Financials and Industrials were, in hindsight, unsurprisingly the largest gainers as these sectors were veritably smashed to bits during the GFC.
We can see in the chart below which is a measure of Industrial Production growth in the U.S. just what a shock to the U.S economy the GFC was.
Even the poorer performing defensive sectors like Telecoms, Utilities and Energy still recorded significant gains
While American and Japanese investors have reasons to be much happier, in Europe, collectively as a region, the evolution of the bull market has been much milder, with the exception of the Dax. The rise experienced in other countries has been much more limited, including the UK. The truth is that Europe has been experiencing a sluggish recovery with many of the Southern economies still in deep trouble and, nearly 6 years after the worst of the crisis, still incapable of closing out a full year with a consecutive Y-o-Y rise in GDP.
What has really made the difference between the 2 major economies is central bank policy. Take a look at the chart below which shows the respective rises of the ECB & Fed. Coincidence that with the exception of Germany, that the US equity markets have performed so well?
Trillions of dollars have been injected into the US since Shinzo Abe was elected Premier in Japan with the BOJ engaging in the most ambitious monetary plan ever in a “last throw of the dice” to turn deflation into noticeable price increases and so get the money multiplier moving again. Early signs are that it is working but at the cost of the trade balance so far.
So, low interest rates around the world mixed with bold monetary expansion explain why the bull market has been so strong and for so long. But there is now reason for concern…
While this bull market is the fourth strongest bull since WWII, the fundamentals behind it are problematic. In previous bull market periods after WWII, the U.S experienced high single digit GDP growth, in particular during the 80’s and 90’s – again, coincidence that this also resulted in the strongest and longest bull market? Similar rates of GDP growth are certainly not the case today. Growth in developed economies is arguably artificial – being generated principally by central bank stimulation through its QE policies. This is not sustainable over the long term or you wind up with a banana economy.
The impressive price increase experienced in stocks is, in our opinion, a direct consequence of QE monetary policy. As the FED has purchased bonds, yields have been flattened to the point where investors have been lulled into a false sense of security regarding the low discount rate applied to equity cash flows and that so supports higher valuations (as the bulls say). But with the GDP growth pace still below 3% in the U.S., we wonder how much longer can this market roll on if monetary easing ends. And so far, Janet Yellen is now showing signs of stopping…
With the promise by the FED to in fact continue cutting the current asset purchase program every month until its extinction later this year, and that has been just under a trillion dollars a year, investors will be exposed nakedly to the “real” trend GDP growth very shortly and in particular to earnings growth as the main dynamic supporting equity prices. With corporate profits at a record high and P/E multipes beyond their median, in fact with tech stocks now back at their pre-2007 crisis level, to us, an adjustment will have to occur. We believe that the risk of the rally ending sooner rather than later is increasing by the day.
We leave you with the chart below and ask – who is left to turn bullish?
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