The Coming Mega-Bull Market

March 20, 2012

Fuel for a bull market in the future in continuing to build up.  Scott Grannis, former chief economist at Western Asset Management, recently wrote about how much cash is piling up.  (His blog, Calafia Beach Pundit, is highly recommended for insight into the global economy.)

M2 is growing above its long-term average annual rate of 6%, even though the economy is 12-13% below its long-term trend.  By far the biggest source of growth in M2 is savings deposits. These have increased by over $2 trillion since late 2008, and have grown at a blistering 15.7% annualized pace over the past three months. This is unusually strong growth that can only reflect great fear and caution on the part of investors everywhere, especially when one considers that savings deposits pay virtually no interest.

Mr. Grannis includes some charts that show both the rapid growth of savings deposits and the strong investor preference for bonds over stocks right now.  We regularly detail the ICI numbers here as well, but his charts are a fantastic visual presentation.

Source: Calafia Beach Pundit         (click on images to enlarge)


We all know what happens when a match finds the fuel; what we don’t know is when or how the match will be struck.  Investors have pretty clearly been traumatized by 2008-2009.  I’m not sure what it will take for investor sentiment to become less negative.  It could be a variety of things: better employment data, less consumer leverage, or maybe some time just needs to pass so the memory of 2008 isn’t so sharp.  This process could take weeks, months, or years.

Fuel, on the other hand, is abundant.  Although struggling consumers and corporations are in the process of rebuilding their balance sheets, many successful companies and consumers with positive cash flow are squirreling the money away.  They are perhaps not comfortable investing it yet, but the cash is building up quickly and could create a tsunami when it breaks loose.

At some point, investors will realize that they need equity-like returns to meet their savings and investment goals.  Or perhaps they will simply become disssatisfied with such low returns from money market funds and CDs.  A trickle of money will start to flow from cash and low-yielding bonds into the stock market, which will nudge the market higher.  As the market begins to move up, investors will become more confident and yet more money will flow into stocks.  The next thing you know, we could have another mega-bull market on our hands, although most probably won’t be willing to believe it.  Plentiful fuel and public disbelief is how bull markets start and then extend themselves.

We’ve already had a more than 100% move from the 2009 lows over the last three years.  The retail investor has not participated much so far.  I don’t know how much longer they will be willing to sit on their hands when it is costing them big money, but if I had to guess, “forever” is probably not the right answer.  We may be closer to an inflection point than it seems.

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The Economy Does Not Equal The Stock Market

March 20, 2012

Aussie Trader, Jessica Peletier, succinctly points out the disconnect often seen between an economy and its stock market:

I admit it – I’m jealous.

Right now, I want to be American.  I want to buy cheap houses and eat mega-huge fast food.

But most of all, I want a stock market that goes up.

Ours appears to have forgotten how.   In fact it’s almost as though it’s pulled the doona over its head and decided never to get up again.

If you ask me, that’s kind of bizarre because you’d think the Australian Market has everything to live for.

You see, economically we rock.  We have stable banks, interest rates that actually pay money and a resource sector that has the rest of the world drooling.  And we have jobs for anyone who actually wants to work.

Now compare that to our American friends.  Their banks have a less than sterling reputation, interest rates can barely go any lower, and there’s very few jobs in many areas – in fact whole towns are dying through the extinction of industry.

And yet their market is merrily making higher highs without a care in the world, while ours is languishing like a drunk on Sunday morning.

It simple really – the economy does not equal the stock market.

What does equal the stock market is people’s perception of what might happen in the future, and this goes some way toward explaining what’s going on with the US market.

Even though right now their economy is junk, people are overjoyed that there are green shoots appearing.  People are more optimistic about the future.  It doesn’t matter that right now, things are still rubbish – the fact is there is hope.

If the markets were a reflection of the economy, the US market may have risen marginally to reflect the odd green shoot.  But what’s happened is not marginal, it’s a beautiful big fat money-making up-trend.

This is exactly why it makes sense to go directly to trading price trends!

HT: Abnormal Returns

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Relative Strength and Value

March 20, 2012

Numerous academic studies, some archived on our website, suggest that outsized returns can be achieved over time by purchasing cheap stocks with high relative strength.  In fact, James O’Shaughnessy highlighted this in What Works on Wall Street as one of the best strategies over the past 50 years.  Lost in all of the hullabaloo over Apple’s dividend, oil prices, Iran, and so on is the fact that the market is undervalued—and has been for most of the past year, according to Morningstar’s fair value estimates.

Source: Morningstar  (click on image to enlarge)

What I know about valuation methodologies could probably fit on the head of a pin, but that’s what Morningstar’s analysts do all day.  When they look at where stocks are selling relative to their estimates of fair value, the market as a whole—and even most sectors—is still undervalued.

Retail investors have been incredibly reluctant to re-engage with the stock market since being burned in 2008-2009.  For a couple of years now, much more investor money has been flowing to bond funds than stock funds.  I’m just not sure if that is a rational move when stocks are undervalued.

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Relative Strength Spread

March 20, 2012

The chart below is the spread between the relative strength leaders and relative strength laggards (universe of mid and large cap stocks).  When the chart is rising, relative strength leaders are performing better than relative strength laggards.    As of 3/19/2012:

RS leaders and RS laggards have had similar performance over the past couple of years.  History would strongly suggest that we will eventually see RS leaders resume their outperformance.

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