The only problem with the rally in world equity markets appears to be in getting the crowd to believe in it! Perhaps this is a good problem to have because the more crowd members there are who don't believe in a bull market in equities (albeit have a bearish view) the more potential buyers there are out there! Yes the market works in strange counter-intuitive ways at the best of times.
World equity markets have more or less completely re-cooped all of their losses made since just prior to the "flash-crash" in early May. However, market sentiment appears considerably less bullish than it was at the end of April. Perhaps the flash-crash has affected investors a lot deeper than I ever expected it would.
Whether or not the crash of 2008 marked the start of the next bull market remains to be seen of course. However, from my limited 20 years of experience in the markets (the last 10 as a professional trader) and my studies of stock market history dating from the American Civil War, we may well be in for a period of significant growth in stock prices. I would like to quote the famous economist A.C. Pigou:
"The error of optimism dies in the crisis but in dying it ‘gives birth to an error of pessimism. This new error is born, not an infant, but a giant; for (the) boom has necessarily been a period of strong emotional excitement, and an excited man passes from one form of excitement to another more rapidly than he passes to quiescence."
If you don't get the hint from that quote then try the infamous words of John B. Templeton:
"Bull markets are born in pessimism, grow in skeptisim, mature in optimism, and die in euphoria".
A dead give away for the crowd's pessimism or "weak-form" skepticism is the outflows from equity mutual funds (particularly of the US domestic variety). In spite of the very significant rise in equities over the course of the last two months there continues to be outflows from mutual funds, from recollection I think we are up to 25 consecutive weeks of outflows (as per ICI). Most analysts would take this as being a bearish phenomenon, I take it as being bullish because it suggests there are plenty of marginal buyers out there for equities.
The lack of enthusiasm for equities is reflected in the tone of commentary. Every time the market advances it seems that a growing chorus echoes words to the effect that; "this market is now well due for a significant correction". It is interesting to note that many commentators who are now in the "correction" camp never changed their bearish view in the first place! Furthermore, it seems that the reasons given for the rally in equities, are mere "excuses". How many times have you read words to the effect that "this rally is not real.....it is solely due to the misguided efforts of the Fed.....eventually the rally built on a house of cards will collapse"? Well it goes a little further than that with the Fed and the "QE" thing being often quoted as the primary reason for the latest results in corporate earnings. Once again we are being led to believe by the average pundit that the increase in corporate earnings is "not real" or that they are "fake"!
I have just read Mark Hulbert's latest piece in marketwatch.com. He is one writer whom I highly respect and I urge you to note what he is currently saying. Mark makes reference to Adlai Stevenson's famous quote of some 50 years ago. Mocking opponents' reasoning, this elder statesman and candidate for president in the 1952 and 1956 elections would say "here's the conclusion on which I base my facts." I think that this quote about sums it all up.......most commentary that one reads these days is mere justification for some preconceived idea that in all probability was never the author's idea in the first place!
For those of you who are fearful of equities.....have you stopped to analyze the developments that have occurred over the course of the last two years which can be taken to be bullish for equities? Here are a few:
- massive injections of liquidity into financial markets by central banks,
- the cleaning up of corporate balance sheets brought on by the financial crisis,
- the lowering of corporate cost bases also brought on the collapse in cash flows in the last half of 2008 and early 2009,
- the dramatic come back in corporate earnings over the last 18 months,
- emerging markets that have bounced back to growth levels in excess of those which prevailed in 2008,
- a shift in wealth with emerging markets now accounting for more than half the world's GDP (so much for the term "emerging"),
- equity valuations on many large cap US stocks that can only be described as very cheap relative to treasuries,
- and perhaps above all, sentiment towards large cap US equities that can only be described as something you use to describe toxic waste!
There are probably a whole lot more positive reasons that one could gather to support a bullish argument. In any event, the behavior of the market seems to suggest that something very bullish is in the process of building. The average stock in the US (as per the equally weighted Value Line Index) is only a whisker away from a multi-month high. The more I look at the behavior of equity indices in the US over the last 6 months the more it reminds me of what took place in the first 8 months of 2004!
Outside of the US the bullish plot only appears to thicken! Look at what has happened to the average listed small cap stock in developed markets ex the US!
And finally the proverbial canary in the coal mine of world equity markets. Emerging market small caps are making new multi-month highs week in week out. Yes even if you look at their behavior in home currency terms (rather than USD which the ETF reflects).
Yes I know there is great uncertainty over what will ultimately be the end result of the huge stimulus efforts by central banks. But as any seasoned investor knows, if there is no uncertainty there is no wall of worry for equity markets to climb. That is, when everything is certain and the future looks "rosy" then there will only be marginal sellers of equities left!
Disclosure: Long DIA, EWX, EEM