How Will This Bull Market End?

How will the bull market in stocks end? One scenario is an escalation in long-term interest rates relative to the market earnings yield (inverse of price-earning ratio) to a point where the incentive for takeovers and buybacks is eliminated.

One way that could happen is through overheating in the world economy. U.S. trading partners will have less need to suppress their currencies by printing domestic currency to mop up U.S. dollars, which in turn will curtail growth in U.S. dollar reserves and the recycling of those reserves into U.S. bonds. The end result: as foreign demand for U.S. bonds trails off, their yields (long-term interest rates) will climb.

Another way in which the bull market can end is through a decline in the market’s earnings yield. This can come about from an appreciation in stock prices at a faster rpace than growth in earnings per share, as is happening now thanks to the merger and acquisitions boom and slowdown in the economy.

In short, keep an eye on China’s so far unsuccessful attempt to cool its runaway economy. And keep another eye on the i) re-rating of stocks driven by the arbitraging of interest rates and the earnings yield and ii) slowing in earnings growth underway as the U.S. economy cools off. At some point, these trends are capable of snuffing out the bull market.

Maybe the end will come as soon as the second half of this year, as veteran technical analyst Ron Meisels suggests in his latest Phases and Cycles newsletter. His bullish market calls have been on the mark throughout this extended phase, but now he is saying: “…by the end of the second quarter the bull’s fuel tanks will likely run close to empty. Therefore, the second half of the year may … bring an end to the 2002-07 bull/bear cycle.”

Comments

[insideoil:]

Maybe the Fed will have to increase rates just to keep the US$ interesting to keep financing USA deficits ?
Consequence will be a US dead stop - but with low inflation ! So no solution here.
Maybe the Fed will just let the market decide - in which case the US$ slowly but increasingly sinks to the point that imports drop and exports rise again as the USA finds its manufacturing base can actually produce goods competitively. A great way to devalue your existing debt, let the Chinese argue with Korea, India etc in Asia over who needs to revalue their currencies, and get the USA back to a long term workable situation. Import inflation will be a problem - but for who, the USA or foreign exporters reliant on the US consumers to keep buying. I know where my bet lies as to how this bull run is going to end - and it will not be pretty for all those reliant on free money and stacked up on debt.
Have I said the same thing - but just another way?

2007 May 14 07:41 AM

[Richie:]

Larry,

If we are not ALREADY in recession, why do we not have any meaningful inflation given:

Deficit financing of the war (annually $300 - $400 Billion)
Massive budget deficits (always inflationary)
Massive trade deficits (that should cause importation of inflation)
Explosive money supply growth vis-a-vis GDP growth
Oil prices up 300% - 400% over the last 4 years
Historically and (unjustifiably) low interest rates (from as far back as Greenspan's reign)

All of the above INDIVIDUALLY, coupled with historically very low interest rates are highly inflationary. As they co-exist simultaneously, we should be living with 10%+ inflation. But we are not. The excess liquidity is all flowing into equities (as real assets decline in value) inflating their value well beyond what earnings growth would warrant.

It seems apparent to me that this paradox can exist only if the economy were in an accelerating decline. Hence, a concurrent mountain of inflationary stimulation has no impact. If you question my thesis, consider the following:

Base metal prices have topped out
Prescious metal prices have topped out
Virtually all other commodity prices have topped out
Oil prices have topped out
Real Estate prices have topped out
GDP growth rates have topped out
Job creations rates have topped out
The dollar is in a state of collapse
Auto Sales (volume) have topped out
Retail sales (volume) have topped out
Inflation rates have topped out
P/E ratios have topped out (years ago)
Mortgage rates have topped out
Equity extraction rates have topped out
Dividend yield growth rates have topped out
Inverted yield curve (invariably leads to recession)
Leading indicators (4 consecutive months of decline)
Public sentiment near record lows
Trucking, airline and rail revenues in decline
Help wanted in serious decline
(Kelley Services, Robt Half, Monster Worldwide)

About to happen: a topping of INTEREST RATES
Next action by FED: a sizeable reduction in INTEREST RATES
Subsequent STOCK MARKET response . . . . .

2007 May 14 12:00 PM

[Malkiel:]

"Another way in which the bull market can end is through a decline in the market’s earnings yield. This can come about from an appreciation in stock prices at a faster rpace than growth in earnings per share"

It's already widely believed that the markets are not offering up enough inventory (shares) to meet the needs of institutional buyers such as mutual funds buying for 401k and pension plans, so unless this changes the prices of shares must creep up regardless of fundamentals. If nothing happens to change this situation the bull market may go on for A GENERATION OR MORE with no important downturns...

2007 May 14 05:49 PM