MARKET SWINGS: NOT A BEAR OR A
BULL, BUT A BUNNY
March 24, 2016 by:
John Authers
AUTHERS’S NOTE: ANIMAL SPIRITS FOMC and OVERVALUED
STOCKS
VIDEO LOCATION: http://uds.ak.o.brightcove.com/47628783001/47628783001_4815006881001_4814307765001.mp4
HAVE EQUITY MARKETS ESCAPED THE BEARS YET AGAIN?
Global stocks started
2016 with a swift fall of more than 10 per cent — the worst start to a calendar
year in history — but have regained all of it. This also happened last summer,
with markets performing a similar swan dive followed by a brisk recovery.
The dramatic swings
have prompted questions of whether the bull market that started in March 2009
is on its last legs. Both US and
world stocks remain below their record set 10 months ago, and the anxiety
that drove two sell-offs remains palpable.
But the debate goes
deeper. Even though US stocks have tripled since their low in the financial crisis,
some suggest that the upward streak of the past seven years was not a bull
market at all. Indeed, there are experts who argue that the bear market that
started when the Nasdaq dotcom bubble burst in 2000 is still going on.
In the shorter term,
debate hinges on the economy. As long as there is no clear evidence of an
imminent recession in the US, it is harder for stock markets to turn decisively
down. James Breech, head of Cougar Global Investments, says: “Bull markets don’t die of old age. It’s always recessions
that kill bull markets. And we have zero per cent chance of a recession in the
next 12 months.”
James Paulsen, chief
investment strategist at Wells Capital Management, says the market behaviour of the last year can be “characterised not by a bull
nor by a bear, but rather by a bunny”. He suggests that such a market
“hops about a bit but really doesn’t go anywhere”, characteristics that often
dominate the stock market during the latter stages of recoveries. Bunny markets
require nimble and opportunistic behavior by investors.
“We’re biased because the last two times we had
a bull market, it went straight up and then, when it ended, it ended,”
he adds, referring to the market crashes of 2000 and 2008. “We lost the feel for a meandering market which is still in a
bull.”
In the short term, traders refer to a cyclical bear market
when a fall of 20 per cent from peak to trough is registered. On that
basis, large US stocks, as measured by the S&P 500 index, have avoided the
bear. They have never been down more than 15 per cent
from their record set in May last year.
CHART 1 OUTSIDE THE US THE
BEARS RULE
But industrial and transport stocks, and smaller US
companies, all seen as leading indicators of where the rest of the market is
heading, were down more than 20 per cent from their highs during the worst of
the action in February.
Even if the S&P
500 did not fall by as much as 20 per cent, it may therefore make sense to call
this a cyclical bear market. Scott Minerd, head of investment at Guggenheim
Partners, says: “You can make a good case that there was a bear market in the
first quarter — but it needs to be better defined.”
Whether the pause in
the market’s onward march was enough to allow another
upward leg of the bull market is
also, he says, hard to answer.
The critical variable is the US economy. John Higgins, chief
market strategist at Capital Economics in London, suggests that US stocks can
continue to muddle along if the country can avoid a recession. He notes the
dollar has started to weaken, flattering the overseas profits of large US
companies.
CHART 2 A GOOD GOUGE OF
VALUATIONS?
“To see a bear market, we have to be wrong about the US
economy, and to see a stronger dollar. The effect of the stronger dollar on
overseas earnings would be a very big deal, and the structural forces that
pushed up the market — globalisation — could be seen to go into reverse.” Mr
Higgins says the key is unemployment. On each of the eight occasions since the
second world war when joblessness has dropped below the “Nairu” — the rate higher
employment begins to drive accelerating inflation — the labour share of the
economy began to rise at the expense of capital, squeezing profits.
The US jobless rate
is at 4.9 per cent, and a strong rise in hourly earnings for December helped
drive the early-year sell-off. It has since fallen back.
A sharp rise in inflation would force the Federal Reserve to
abandon the low interest rates that have helped to finance the boom in stock
markets, and could also push up bond yields. Historically low rates have
been critical in supporting the equity bull market.
CHART 3 BEAR MARKET “Different
characteristics on Display”
David Bowers, head of
research at Absolute Strategy Research, agrees: “The
core risks are around where unemployment is going. If the unemployment rate is
going down, it’s still an environment where stocks can do well, certainly
relative to expensive Treasuries.”
Outside the US, which accounts for 43 per cent of
global stock market value according to Datastream, the
story is clearer. Stocks rose to a post-crisis peak in 2011, and have been
mired in a bear market ever since.
In emerging markets, according to the latest regular
Bank of America Merrill Lynch survey of global fund managers, investors are their most underweight in 15 years, a classic
sign that a bear market bottom may be near.
Here, markets are following a familiar pattern seen after previous
crashes that followed speculative bubbles, such as the Wall Street crash of
1929, the Japanese bubble that peaked in 1989 or the dotcom bubble that
peaked in 2000. In all cases, markets shed about 60 per
cent, and then moved sideways for many years before bottoming out.
CHART 4 US PROFIT’S SHARE OF
OUTPUTS LOOKS VERY HIGH
In the US, where
stocks are far above their pre-crisis highs in 2007, the question is how they
managed to avoid this pattern. Some financial
historians question whether market cycles are linked to the economy. Rather, they tend to see markets following longer secular —
not cyclical — bull and bear trends, influenced by social mood, economic
and profit cycles and, most importantly, swings in valuation.
Russell Napier, a
stock market historian and author of Anatomy of the
Bear, says both bull and bear markets are long, drawn-out affairs. The bottom of bear markets, which see a steady collapse in
equity valuations, is only hit when all hope in equities has been lost,
and there were only four such low points throughout the 20th century. “Very high and low valuations can’t just be attributed to the
business cycle because they are too rare,” he says.
He adds that March 2009 was not a true bear market bottom because equities
were not cheap enough, implying that stocks will need to fall back to that
level. To measure these broad cycles, he uses cyclically adjusted
price/earnings multiples, which correct for the business cycle by comparing
share prices to the average of earnings over the previous 10 years. A measure
known as Tobin’s Q, which compares the value of companies with the total
replacement cost of their assets, yields a similar conclusion.
CHART 5 SECULAR BEAR
MARKET CYCLES
LONG VIEW
It may seem absurd to suggest that the US is still in a bear
market after seven years in which share prices have trebled, but Mr
Napier draws a comparison with the long rally from 1932-37, in the midst of the
Great
Depression. That rally ended when the Fed raised
rates in 1937 prematurely, and the bear market
did not end until years after the war.
“There is some
parallel between what’s happening now and 1937,” he says. “We haven’t seen America attacking business yet, like both
Roosevelts did. You have to reach a change in policy — anything that
reverses the changes of the Thatcher-Reagan era,
and causes returns on corporate capital to decline.”
On this reading, the populist mood in the US presidential primaries,
and in various European countries, could spark the kind
of sentiment that leads to the bottom of a bear market. Once governments
start taking a more dominant role in the economy again, he says, then “the ideologues in the market will overreact and not notice
it’s cheap enough on the way down”.
Ed Easterling,
founder of Crestmont Research, agrees that the bear
market that started in 2000 is still going on, and says the market grew
so overextended during the dotcom bubble that it will take many years to
correct.
CHART 6 THE US STOCK
MARKET CAPITALIZATION
Image of “Stock market
capitalization” https://www.ft.com/__origami/service/image/v2/images/raw/http%3A%2F%2Fcom.ft.imagepublish.prod.s3.amazonaws.com%2F0fd6ccd0-f121-11e5-9f20-c3a047354386?source=next&fit=scale-down&width=600
“The bubble bear since 1999 is different, and it’s not driven
by time but by magnitude. The multiple has come down as much as it
usually falls during a secular bear, but we started higher — that’s why we still have a lot further to fall,” he
says.
Japan, where stocks
are barely half their level at the end of 1989, might
be a good indicator of what to expect.
How then to explain the rally since 2009? “That’s
because the Fed has been successful, and worked to raise the wealth effect.
It’s amazing what $5tn can do. But I don’t think it’s
plausible that we’re starting a secular bull.”
To do that, Mr Easterling says, earnings multiples need to
fall so low that they can double or triple over time — a shift that might come with inflation.
“The stock market is about fair value now. In reality we’re not very overvalued because rates and inflation are so
low. What we could talk about is a bear in
hibernation. We would keep valuations high, but in
a decade from now we are about where we are now and our returns have been a lot
below average.”
CHART 7 INFLATION AND
CAPE
Image of “Inflation and Cape” at: https://www.ft.com/__origami/service/image/v2/images/raw/http%3A%2F%2Fcom.ft.imagepublish.prod.s3.amazonaws.com%2F0efa5750-f121-11e5-9f20-c3a047354386?source=next&fit=scale-down&width=600
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Copyright The Financial Times Limited 2017. All rights reserved. You may share using our article tools.
Copyright The Financial Times Limited 2017. All rights reserved. You may share using our article tools.
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