One of the things I have liked and mentioned about the present market environment is the fact that the "bulls" are nervous, even a little embarrassed, constantly looking over their shoulder for that elusive correction many are predicting. The bears still seem confident with their seeming unending calls that "this" is the 'Top" .
That sets up as a "perfect" environment for equities to move ahead.
Let's take a look back at this year. The market stumbled out of the gate this year and all seemed to jump on the "party is over " bandwagon as the S & P pulled back to the 1750 level in February. Then a decent rebound to new highs in April when the S & P rose to 1890. Along came the new calls for "THE TOP" and of course the "sell in May" train was well on its way..
Unfortunately for the bears it was derailed with new highs being recorded here this past week @ S & P 1962. My commentary last December and earlier this year is that Stock selectivity would be more important than ever in 2014. Also suggesting to continue to avoid the market "noise", whether it be Fed related or media punditry that was touted about the "economy this and the economy that". Those thoughts and commentary has indeed played out..
So, probably the prudent "call" would be to declare victory, tell all to sell, & wait for that elusive correction... After all we have had a 200% + gain with this market rally ( some accounts have actually tripled) , against an economic backdrop which has extended nearly 5 years, a bond market whose low yields could be signaling rough economic waters ahead, and a variety of global political and economic risks running from the Ukraine through the Mideast and right to China.
So that would be the EASY call, and there seems to be many pundits that are doing just that. However, I won't be suggesting to hit the "sell" button right here. That should NOT imply that I am throwing caution to the wind. I have often suggested prudent investors should harvest outsized gains on stretched positions, sell upside calls and always have some dry powder to put to work on pullbacks.. and as already noted - be selective with your stock selections.
In my view, its not time to call this 'The Top" as we have just recently exited a 13-year secular bear market in equities, and entered into a new secular Bull market when the S & P 'broke out" in March 2013 above the former 2000 & 2007 highs.. This secular Bull run has plenty of runway left before its over and I have written numerous updates on this blog as to why I believe that will be the case..
The S&P today is 26% above its peak in 2000-a nominal return of just under 2% per annum over these miserable 13 years, below the rate of inflation. Over this same 13 years, nominal S&P earnings have risen from $68 per share to over $110; nominal U.S. GDP, has expanded from $10.3 trillion to $16.8 trillion (global GDP, by the way, has more than doubled); and the investment alternative, the U.S. 10-year Treasury bond, has seen its yield fall from 5.1% to 2.6%. Not to mention the other bond yields around the world aren't offering anything exciting in the terms of yield and of course they bring more risk with them. Where is that foreign investor going to put his/her funds..? I suggest the US equity market is giving them their answer. Its just another factor that many dismiss or ignore as they continue to question who is "buying" this market.
I don't see it as "how close are we to the end" as many wish to offer as their daily "call" , rather "how far from the beginning" are we?
My reply to that , not far, not far at all from the beginning. Many are still very skeptical at the moment about the future, and are warning us all to hit the sell button and wait for things to implode.. I hear it weekly ...
But perhaps its "Goldilocks" all over again.
Now, The "Goldilocks" scenario was frequently used to describe the U.S. economy and equity market in the mid-1990s. The idea and concept was to have an economy growing "not too hot, and not to cold" that would allow for a gradual expansion in the economy and corporate earnings, while keeping the Fed on hold-and equity valuations stable. Between 1994 and 2000, it happened . Real U.S. GDP growth averaged 3.8% per year, Fed policy kept the 10-year Treasury yield mostly in the 5.5% to 6.5% range, earnings grew 8% per year, and the S&P rose 21% per year.
What drove that scenario was the mania which developed in the back half of the decade in technology, telecom, and media stocks, the so called "new paradigm." This all came to an end when the 2001 recession hit and the bubble in technology-media-telecom stocks burst.
So as we muddle through 2014, investors have been exposed and therefore "trained" with a mindset based on a 13-year bear market in equities and always fretting that the "end must be very near"
I keep writing and updating the earnings history and earnings scenario here in this blog. In my view the foundation for economic acceleration is extremely well laid, and with this, I believe S & P earnings will indeed accelerate to $120 per share this year, and higher still in 2015. I have laid out my Secular bull theory and the 'demand drivers" that I believe support my views. Seemingly when most were warning that the end of the financial world was lurking around just about every corner, U.S. businesses and consumers now find themselves massively under invested with piles of cash all around them.
Slowly, the sentiment is shifting from those fears and almost all forward indicators of an advance are pointing to expansion: bank lending, manufacturing ISM, non-manufacturing ISM, retail sales, consumer confidence, business confidence, M&A activity, etc. This time around, with corporate managers running their businesses lean and mean to prepare for the worst, I believe that will represent the earnings acceleration I am expecting. This week we can add the Philly Fed index to the other positive data presented here as the index came in well above consensus estimates. Of course we will hear that the quality of corporate earnings is weak, corporations can't keep cutting expenses, etc..
My response --given the technological improvement we are witnessing -- yes they can, and have been for the last 4-5 years, and it will continue .. Those that are still focused on employment numbers and equating THAT to how they view the economy, have and will be left behind.
Its simple --- Corporations don't need the workforce to get the job done as they did in the past -- and any obsession with the 6, 6.5% or any other employment number one may wish for is losing sight of what is really going on around them..
Another perception that will come into focus as a positive influence--and goes along with that subsiding of 'fear" -- the decline in perceived risk. That has been an ongoing story since 2009 when we realized that the world really didn't end.
This gradual realization (many still can't see that for what it is ) that risk was on the decline has in fact been a big driver of the equity expansion to this point, with the S&P P/E multiple rising from under 11 times in 2009 to over 16 times today, and the VIX "fear" gauge dropping simultaneously, from north of 60 at the peak of the 2008-09 crisis to just 11-12% today.
The naysayers now say that perceived risk as measured by the VIX is now "artificially low" and bound to "return to normal" any day now. It's just another argument that is being presented (almost daily) now, simply because many of the "old" arguments from that crowd have been disproved -- Remember the "fed could never taper" warnings and "equities would in fact crumble" when tapering begins.. So, now the story is wait until the "punch bowl " is pulled away altogether... and the VIX is too low.. so surely something has to give.
It was nonsense then and that along with their "Vix" argument is nonsense and more "noise" now.. and here's why:
My view is what we are seeing now in the Vix is normal. Its just many are still scared and reflect back to an upsetting market experience when the Vix spiked and spent a lot of time at increased levels.. It was a nightmare that many are still reminded of.. and its understandable.. But that really isn't "normal" .....
However, in more benign, boring environments, such as where we are now and where we are heading, the VIX has spent years in low double digits (for example, 2003 to 2007, and 1992 to 1996). Today, even with the VIX at 11-12, the 12-month forward curve has it much higher, near 19%-so investors continue to expect volatility to rise again, and are pricing this into risky assets such as equities. What if the reverse were true? (Which i suggest is unfolding before our eyes) What does that do to pricing of equities.. ? The naysayers hanging their hat on that argument may be in for yet another surprise..
With government deficits dropping quickly as their economies expand, (I've demonstrated this as being one of the secular bull demand drivers) these quantitative-easing programs are effectively buying up a larger and larger percent of the new supply of government bonds. At the same time, geopolitical uncertainty outside the U.S. and Europe is driving up demand for the perceived safety of U.S. and European government debt. So both supply and demand forces are keeping yields artificially low, even as equity risks are declining and equity earnings are rising.
Additionally, Im not buying the perma-bears cries that the housing market is dead. Understand that the pace of housing growth going forward will be more of a data dependent grind over the next few years. That is in contrast to the powerful, outsized rally we enjoyed off the housing market's cycle trough in the fall of 2011. But the latest data itself does not portend the end of that "cycle"
With sentiment still broadly skeptical at best, this wall of worry over issues real and/or imagined continues to provide a nice backdrop for equities. Add in, declining equity risk ,rising equity earnings and prolonged low yields--
RESULT--- In my opinion, another leg higher in the equity market is in store. The timing of that is anybody's guess and its like trying to predict the weather as to when it will happen. What I do know is that the LT trend in equity prices has not been disturbed and is decidedly UP.
We are now entering the "summer doldrums" and maybe we will hear about the 'mid term election cycle effect" again, who knows. It would not be surprising to see a pullback from these S & P levels, given the advances we have now cataloged.. There is history that suggests that the coming months on average are weaker periods for equities, and the general consensus is now suggesting that. I'll note that was the "consensus' last year as well, and the market just marched higher.
However, IF a pullback or correction develops , I believe it will set up the averages for another shot at fresh new highs..
I am staying the course and adding to the names I have mentioned in this blog- trimming some of the exposure I have in the oil sector which has provided substantial gains in the first 6 months of 2014 and is a bit "stretched" at the moment..
Don't play it "cute" & attempt to outwit the market.
It's easier to take what the market is giving us. Stay the course.
Best Of Luck to all !!
Disclosure: The author is long LVS, FFIV.
Additional disclosure: I am long numerous equity positions - all of which can be seen here on my Instablog."It is my intention to present an introduction to these securities and state my intent and position. It should be used as a 'Starting Point' to conduct your own Due Diligence before making any investment decision.