I find it rather ironic how the main stream media and investors in general can be so pessimistic about the market. Since March 2009 we have seen one of the most powerful bull runs in history, with the S&P 500 gaining just shy of 150% growth in that time.
This fear has helped prop up bonds with an inordinate amount of money stored in them. Well that is until now, with hints of QE about to end this has caused quite the outflow from bonds and therefore pushing yields up.
With all these funds leaving bonds you'd expect it to push up the broader market such as the S&P500 yet that is showing signs of anything but, at the moment. Surprisingly we're in a unique situation where even the safe havens aren't safe anymore, there certainly isn't faith in equities or real estate at the moment and commodities are out of favor also. One thing is for sure however, all this money has to go somewhere.
As you can gather from the title of this article, I remain bullish on equities. Interestingly enough, if you tune to any mainstream columnist and pundits they would have you believe a crash is imminent. Supposedly before the year is out. I also find it rather interesting how the bull run no one talked about is now being brandied around as evidence that a crash is imminent. Not too different to saying what goes up must go down. Further evidence used is that we've been in a bull run for 5 years and statistically compared with other bull runs a crash is therefore imminent.
I certainly don't agree and correlation is definitely not a case of causation, in fact that's how superstitions are formed. My view is that this market still has legs and quite the distance to go with the 2000 level potentially being reached by the S&P 500 within the next 12 months.
Before I go on to discuss my reasons for why there are still legs in this market I will mention a few things that may impede that in the short term. While a correction may occur of 10% or so, I don't see a crash. At the moment however, there is some uncertainty in the markets and, as is generally the case in times of uncertainty, the market treads sideways, poised ready to react at the next sign of significant news.
With Syria, QE and the U.S. Debt Ceilings currently on the table this is going to stunt any real movement in equities.
Remember what I said earlier that correlation isn't causation. On the surface and from a technical level it can be argued that the signs of the S&P500 are the same as the 2000 crash and subsequent demise in 2008. I beg to differ.
Yes a triple top does seem to have formed, yes its roughly the same amount of time between the tech crash and GFC. However fundamentally the markets are very different.
One of the first things a contrarian would look at is to see the sentiment of the market at the time. With so much negativity in sight, its hard to see how a crash could occur as investors are already too nervous. Crashes typically occur during optimism and times of euphoria. If we look at the University of Michigan Consumer Sentiment Survey,we can see that while it is improving, it's not even at its historical average. The market has quite some room to move before we can say we reach those levels of euphoria or optimism.
The EPS (Earnings Per Share) of the S&P 500 is higher than it was during the GFC. Analysts each quarter remain bearish on their forecasts and the earning estimates on average are beating those forecast. Coupled with the fact that around 20% of shares in the S&P 500 have been part of a share buy back program. This has therefore decreased the volume aiding the higher EPS and with the reduced volumes it wont take much to see the market soar once optimism grips.
The below graph shows the S&P 500 adjusted to inflation vs EPS.
It is evident that a lot of the fear of a crash is the fact the U.S. Fed will be easing its QE program, with its possible cessation in the middle of 2014. It can be argued that the Fed is artificially propping up the markets by printing money and keeping yields artificially low. However there is no doubt that this is stimulating the economy, whether you believe the positive economic data is falsified or not. It comes down to understanding economics. Having spoken to several investors or in other words the smart money, it is apparent they are taking advantage of the low yields to build their business or add to their leverage.
Im a firm believer that nothing in this universe can occur without consequence, or in other words for every action there is a reaction. QE1, 2 and 3 show subdued growth so while this is used as an example to show it hasn't worked. Im of the view it is more so the calm before the storm. With reduced consumer confidence and optimism, we haven't seen the monetary velocity to perpetuate the economy and cause radical escalation in inflation.
So while QE will certainly come to an end at some point, this is necessary to prevent inflation getting out of control and ultimately this will lead to interest rates rising. Interestingly the yield curve prior to the tech crash and GFC was horizontal. In other words the short term lending rate vs the long term rate was the same. This ultimately discourages long term borrowing and another hint the markets were becoming out of favor. A healthy yield curve is where the short term yields are low in comparison with the longer term. Consistent with what we have now.
If we look at the chart below which is where it was at prior to the GFC you can see the rates along the whole yield curve were identical. This discourages long term borrowing and encourages parking money into cash for safety and guaranteed returns.
Now, if we look at the current yield curve we can see its rather healthy.
I can sense that there will be some argument that yields are now rising. While that is in fact true, the long term yields have risen quite sharply compared to short term yields. So while there is that disparity and curve between long and short, that is a sign that the market remains healthy.
Given my article has contrarian views in nature I can foresee the protests it will generate and I encourage responses below.
So how can we apply a bullish view? Firstly I see any pullback in the market as a buying opportunity. Simply investing in the index such as the S&P500 (SPY) is relatively easy without having to evaluate individual companies. The small cap stocks tend to also be a leading indicator into market health so for those who wish to diversify or go a little riskier you may wish to look at the Russell 2000 (IWM).
Ultimately you will have to form your own view. While I do see a crash occurring, I don't see it anytime soon and for now the bulls have the advantage.