posted on 05 March 2017
by Lance Roberts, Clarity Financial
On Friday, I penned:
It did surprise how similar the two patterns were to each other, with both of them getting nearly 9% above their 200-day moving averages.
But similarities in price actions alone do not necessarily equate to problems for investors.
Today, due to the impact of technology, online investing, high-frequency trading, dark pools, hedge funds, etc., prices are more of a reflection of short-term investor sentiment rather than a reflection of the long-term fundamental investing. With an average holding period of 6-months or less, a long-term fundamental case for owning an investment does not have the “time frame" necessary for the analysis to mature.
The problem with very short-term holding periods is the impact of “psychology" on investing outcomes. This is why the discussion of the rise of “animal spirits" within the markets is currently an interesting topic, given that such a rise in “exuberance" is often equated to the end, rather than the beginning, of an investment cycle.
We see the same situation in the economic backdrop as well.
If this market rally seems eerily familiar, it’s because it is. If fact, the backdrop of the rally reminds me much of what was happening in 1999.
If you were around then, you will remember.
The charts below show a comparison of GDP, Inflation, Interest Rates (10-year) and the S&P 500 between 1998-2002 (dashed lines) and 2014-Present (solid lines). The data is nominal and quarterly.
While inflation rates and GDP growth are substantially weaker than in 1998, the recent turn higher is similar to what we saw during that previous period. Notice in 2000, there was a spike higher in GDP which got the bulls all excited just before the recession took hold.
The same is true for interest rates which rose about 1.5% between 1998 and 2000. Rates then resumed their long-term downtrend in conjunction with the onset of a recession.
Of course, as rates, inflation, and economic growth were rising by small amounts, investors pushed assets prices higher expecting the longest economic growth cycle on record to continue for another decade.
As pointed out this past week by my partner Michael Lebowitz, all of the underlying fundamentals don’t support valuations at current levels either. To wit:
The last chart gives a better comparison.
I have combined interest rates, GDP, and inflation into a single “economic index" for both the 5-year period beginning in 1998 and 2014 to present. I then recalibrated the 2014 index and market to 1998 levels.
This is where it gets interesting. If you look at the chart you would quickly make the argument that we have 8-10 quarters ahead of us before a problem occurs. However, because we are running at HALF of the previous rate, there is substantially less room to fall before a recession sets in. In other words, in 1998, the economy had to decline from a 7.5% growth rate to hit recessionary levels.
Considering we are at 2% today, the time to recession will be considerably shorter - like 2-4 quarters kind of short.
For the skeptics, here is the actual data graphed from 1997-2014. Stocks entered the melt-up phase as the “Bullish Mantra" changed from:
The mantra of higher inflation and higher rates is good for stocks has once again returned as stocks enter their “melt-up" phase of the advance. As shown above, it wasn’t the case then and it likely won’t be the case now.
While there is much hope the new President, and his newly minted cabinet, will “Make America Great Again," there can be a huge difference between expectations and reality. And, like in 1999, there is just the simple realization that eventually excesses will mean revert.
But like I said, with only a 6-month holding periods, fundamentals “need not apply."
So, while I don’t like chart price comparisons in general, if you take the sum of the economic and fundamental data above and compare it to previously “overly exuberant" periods, you see this:
Here is the point.
As I discussed above, there is a tremendous amount of rationalization by investors who have never lived through a bear market grasping at a fading number of straws to support a bullish bias.
However, it is NOT the “bullish bias" we need to support.
We are already invested.
We need to be paying attention to what eventually causes the “bullish bias" to end.
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