A rally of 150 per cent – the rise in the S&P 500 since its intraday low of 666 in March 2009 – looks like the very essence of a bull market.
Adjust for inflation and it is possible to see as merely a bear market rally – perhaps the biggest dead cat bounce of all time. The real capital value of an investment in the S&P 500 is still below where it was in 2007 or 2000. After both of those peaks and subsequent crashes, shares were pumped up by central banks keeping interest rates much too low. Read more
We all know that reported earnings are manipulated. But are they manipulated any more than they used to be, and are they manipulated so as to overstate profits, or understate them? And is the manipulation now so extreme that it is no longer relevant to compare profits over long periods of time? That is where the debate over CAPE (the cyclically adjusted price/earnings ratio) has reached. Even if it sounds technical, it is of vital importance when trying to work out whether the market is undervalued – as much of the stock broker community likes to argue – or in fact overvalue.
For those who missed them, the FT recently published my latest Long View column, defending the cyclically adjusted price/earnings ratio as calculated by Robert Shiller of Yale University and its relevance, quickly followed by a Market Insight column from Jeremy Siegel of the University of Pennsylvania’s Wharton School, and author of Stocks for the Long Run, arguing that Cape’s “overly pessimistic predictions are based on biased earnings data”. An academic conference on the subject is coming up in September.
Some navigation might be helpful. This is not just an arid academic dispute but a matter of critical interest to practising investors. As discussed last week, CAPE has been an impressive metric of value for over a century, and it sticks out from other metrics at present by signalling that stocks are badly overvalued (by 63 per cent for non-financials according to Andrew Smithers, a firm advocate of CAPEs as defined by Prof Shiller). Various different exchange-traded funds are now available that attempt to time switches between sectors based on their CAPE ratios.
However, the fact that CAPE is so bearish makes it unpopular. So does the undeniable fact that CAPE has been too bearish to be of great use to the average asset allocators over the last decade, failing to signal that stocks were cheap before two separate rallies, both of which saw stocks double over a period of four years. (You can see charts of CAPE over time in earlier LongShort posts here and here). Proponents of CAPE would counter that the measure is not for tactical asset allocation and that valuations cannot be used for timing the market.
So bulls are now trying to show either that Shiller’s CAPE was always flawed, or something has happened in the last decade or so to make the measure less useful. The academic participants know a lot of money is riding on this. Much more after the break. Read more
Christmas has come early for US traders – Christmas trading levels, that is. Volumes in the benchmark S&P 500 index are down to levels only seen in the last five years in Christmas week. Perhaps investors are just determined to enjoy their time at the beach after having to deal with a crisis every summer for the past three years.
Whatever the cause, the volumes are miserable. The thick line here shows the five-day moving average, smoothing out the daily swings in the thin line. The five-day average has just dropped below the low point of last August and is now the lowest apart from Christmases since Bloomberg’s data series started in 2008. Read more
The US Federal Reserve’s support for the markets can be measured lots of ways, from the impact on bond yields through to comparisons of equity prices and the central bank’s balance sheet. Here’s one I rather like, with a hat tip over to BNP Paribas’s William De Vijlder.
The third round of the Fed’s quantitative easing, or QE∞, is now 41 weeks old, and during that time there hasn’t been a single really bad week, which I defined as a loss of 2.5 per cent or more. The last time there was such a long period without a big down week was during QE2. Before that it hadn’t happened since early 1997.
The total loss of all the down weeks since QE∞ began, including weeks with only a small loss (a somewhat odd measure, obviously offset by plenty of up weeks) has been just under 18 per cent, close to the lowest reached over rolling 41-week periods during the “great moderation” of 2003-2007, and to that reached under QE2. Read more
Cue great excitement. All those pre-written articles and commentaries on the S&P 500 passing its previous closing highs can be rolled out, and there is something for the 24-hour TV to talk about other than the rather small queues at banks in Cyprus.
Just a couple of small flaws: Read more
Reasons to worry: the S&P 500 is back above its dotcom bubble high today and just 1.4 per cent below its 2007 credit bubble high of 1,576.
This makes investors feel happy, and when they are happy they tend to buy more shares. In this sense equities are a Giffen good like a Rolls-Royce: the higher the price, the more people want them. Until, suddenly, they don’t.
For those who believe the market is truly efficient, rising shares merely reflect a changed reality, and the potential gains from here are just as good as at any other time. But the market is not truly efficient. Investors are growing complacent, which adds to the risk of a correction.
The market may well carry on up (one driver would be the combination of good news on the economy and further signs from the Fed that it will not tighten monetary policy), but the fact of its having risen should play no part in a decision to invest, momentum trading strategies aside. Watch yourself. The time to buy is when shares are cheap, not when they are expensive. Shares, particularly in the US, clearly offer less upside than they did a few months ago.
We now face a giant triple top in the markets, as this chart of the S&P 500 shows:
Companies are talking down their earnings prospects at a record rate. For the second quarter of this year, negative pre-announcements have outnumbered positive ones by the most since the third quarter of 2001 – the quarter that included the 9/11 terrorist attacks.
That kind of shift in earnings sentiment would usually be damaging for stocks. But in this interview, Citigroup’s Tobias Levkovich comes up with an interesting argument that the worst is already over – providing the US avoids a recession.