Crash in May and run away, right? Just like last year, right? We'll need a massive infusion of cash from "Helicopter" Ben Bernanke and his worldwide brotherhood of Merry Central Bankers or stock markets will crash hard during the second half of the year, right?
Wrong. In fact, U.S. equity markets are about to erupt into a vertiginous rally that may last right into the elections...and beyond.
And here's even more good news. "Soft" measures of sentiment have nothing to do with this prediction. Sure, there's the latest AAII Sentiment Survey that showed bearish sentiment rising to a seven-month high and bullish sentiment falling to an eight-month low. Sure, I'm glad to hear that too many investors have clamored onto the short side of the boat; when they frantically cover their positions they'll just make it more of a rocket ride. Yes, nice to hear. But whatever.
No, here's the real reason why we're going to rally, and rally hard--because current conditions bear almost no resemblance to conditions of last May, when markets reached a breaking point after months of accumulated stress.
Twelve months ago, the tensions that triggered the Great Summer Crash of 2011 had been building for the entire year, as the S&P 500 chugged ever higher even while investors piled into risk-averse securities like Treasury bonds, Consumer Staples, and Utilities. Herein lay the "tell" that the stock market was headed for trouble: The S&P 500's rise was strong, but the rise of these recession-friendly securities was even stronger. In essence, the market began anticipating a swoon long before most people became aware of it.
When you think about it, the market's reaction makes sense. The Federal Reserve's Quantitative Easing stimulus program was stimulating the economy--and juicing the stock market. But it was a temporary fix. A "quick fix." And the market reasonably deduced that the end of QE would mean the end of the stimulated economy. And, of course, the market was right. QE2, which followed QE1, was then followed by the more modestly scaled "Operation Twist," which will twist to its conclusion next month.
So why won't the market follow last year's footsteps, anticipating the end of central bank stimulus? I'll venture a theory on that in a moment, but first let's take a look under the market's "hood."
Here's a price chart of the NYSE Composite Index that rather starkly conveys the difference in the respective market conditions of May, 2011 and May, 2012. Each price bar in the top panel represents one week of price activity.
What I've done here is to compare the NYSE Composite Index's price activity to that of two "bull plays"-- Financials (XLF), Technology (XLK)--and two "bear plays"--Consumer Staples (XLP) and Utilities (XLU). I've used a little bit of math so I can make apples-to-apples comparisons between the NYSE Composite and each individual sector, with the relative strength or weakness oscillating above or below zero.
Bottom line: When the black line is below zero, it's bearish. When the black line is above zero, it's bullish. So with that in mind, let's marvel at the consistency of the pattern.
(Click to enlarge images)
Last May, the stock market as a whole was showing greater strength than tech stocks. That's bearish. This May, tech stocks are showing greater strength than the stock market as whole. Bullish.
Last May, the stock market was showing greater strength than financial stocks. That's bearish. This May, financial stocks are showing greater strength than the stock market as whole. Bullish.
Last May, the stock market was weaker than consumer staples. That's bearish. This May, the stock market as a whole is showing greater strength than the consumer staples sector. Bullish.
Last May, the stock market was weaker than utilities. That's bearish. This May, the stock market as a whole is showing greater strength than the utilities sector. Bullish yet again.
I could go on. In fact, I will...with one more chart. Here's a daily bar chart of the NYSE Composite Index, with the same algorithm showing its performance against 20-year Treasury bonds. First, let's look at this year's chart, with the stock market as a whole showing markedly greater momentum strength than Treasury bonds.
Now, here's the same chart showing the same time period last year.
Sort of speaks for itself, doesn't it?
Now why would the market be ready to rocket with all the chaos in the world today, with the economy as fragile as it is, with a QE3 itself far from certain? One could speculate that a de-facto QE3 is already underway, with rising asset prices and plummeting interest rates creating the aura of prosperity that any self-respecting central banker would hope to conjure. But who knows?
In times like these, facts are the only things we've got. And the facts point to one conclusion: That the Bulls of Summer are upon us.