In 2009, the basic rationale for driving stock prices higher leans heavily on the 'less bad' perception of future economic activity. The markets, as evidenced by credit spreads, commodity prices, and stock prices, have been able to move away from “the end of the world as we know it” mode. An unprecedented amount of economic stimulus and newly printed money has helped shift the primary fear from one of deflation to a possible loss of purchasing power caused by deflation. The market’s perception seems to be “if things get worse economically, and they may, the policymakers’ response will be more stimulus and more printed money”. This perception coupled with the “less bad” outlook has increased the demand for inflation-friendly and weak-dollar assets (oil, gasoline, copper, emerging market stocks, foreign bonds, commodity-related currencies, etc.).
Since humans have been greedy and fearful since the beginning of time, they tend to act in similar ways before, during, and after a financial crisis. These tendencies manifested themselves during the tulip bulb craze of the 1600s, the dot-com craze of the 1990s, and the real estate mania of the 2000s.
The table shown below allows you to visualize the transition that has taken place between March and June of 2009. In March (far left side of the table), most markets had the characteristics of a bear market. Currently (right side of table), numerous markets look much more like an early bull market than an on-going bear market. Below, we will use the S&P 500 (2000-2004) to illustrate and expand on the concepts as they relate to the current day and the information presented in the table below. Click on tables and charts for larger images.
By studying past bull and bear market cycles, we can better understand what to look for during a possible transition from a bear market, dominated by fear, to a bull market which eventually becomes dominated by greed. If we are not aware of the twin thieves, greed and fear, they will rob us and hamper our ability to grow our accounts. As we have stated in the past, in a bull market:
- Price tends to stay above the 200-day moving average (MA) (red line).
- The 50-day moving average (blue line) tends to stay above the 200-day moving average.
In bear markets, professionals tend to buy at extreme points of pessimism looking for a profitable trade. Traders often ride a market back to its 50-day or 200-day moving average and then take profits. In a bear market, traders tend to sell at the 50-day or 200-day because their fear of losses remains greater than their confidence the market can move higher. Their lack of confidence speaks to their pessimistic view of future economic activity. Bear market rallies are mainly fueled by traders and lack participation from longer-term investors.
In a bear market (see above), where conviction is lacking to push prices higher:
- Price (black line) tends to stay below the 200-day moving average.
- The 50-day moving average tends to stay below the 200-day moving average.
At some point in a bear market, the perception of traders and investors slowly starts to shift toward the acceptance of better times ahead (or "less bad" times). When their confidence, and more importantly their conviction, becomes strong enough, instead of selling at the 50-day or 200-day moving average during a rally, they hold thinking the markets may be able to move higher. If enough investors and traders share the same improved outlook, a market is finally able to clear previously insurmountable hurdles in the form of the 50-day or 200-day moving average.
Emerging Markets Have Led The Way Higher
Since the S&P 500 is a laggard in the current market, we will use the Emerging Markets Index to illustrate how numerous leading markets, asset classes, and sectors look in June of 2009. If you compare the chart of the Emerging Markets Index below to the This is What A Transition From A Bear To Bull Looks Like chart above, and do it with an open mind, you will be hard-pressed to come away with a bearish interpretation.
Part Of The Pattern: Not Accepting The Possibility Of A New Bull
The fact few are willing to call the current rally anything more than a bear market rally fits well with the historical profile of new bull markets. No one, including us at CCM, can definitively say a new bull market has or has not started – only time and future market action will tell. However, we can confidently state that what has transpired since the March 2009 lows compares very favorably with the end of a bear market and the beginning of a new bull market. How long a new bull might last is also something that can only be definitively answered in retrospect. While market conditions have improved, risk management must remain a significant part of any investor’s game plan. Even bull markets can experience significant corrections.
Disclosure: The author and CCM clients hold numerous postions including TBT, exposure to emerging market stocks, foreign currencies, commodities, and foreign bonds.