Part I: A Bear Market Bottom?
May 6, 2009
I don’t know if you’ve been following the financial headlines lately (or if, like many, you stopped reading them a few months back out of respect for your mental health). If you haven’t you may not be aware that since March 9 the S&P 500 has risen 37%. That’s right. The stock market has increased in value by over a third in a month.
This is the kind of powerful move you typically see as a bear market is dying and a new bull market is being born.
To be fair, you can also see this kind of rally well before the end of a bear market. One such example was from 1938. And even more recently, from November 20 of last year to January 6 of this year the S&P 500 gained 24% only to then roll over and fall to new lows.
So, the question of the hour is: Which is it? A bear market rally or a new bull aborning? The answer, of course, only time will tell. But there are differences between this move and last November’s that are worth pondering.
First, as noted in our April Economic Outlook [here], the November rally was more a result of sellers’ exhaustion than any surge in buying demand. That is, stocks rose reflexively simply due to an absence of sellers. I won’t bore you with all the details, but that kind of rally has weak trading volume, the gains aren’t widely distributed (bad breadth), etc. The market is going up but without much conviction.
The rally that started March 9, on the other hand, is a clear and powerful expression of exploding demand: volumes have been huge, gainers have outnumbered losers by multiples (often 3:1), gains are very widely distributed, etc. ISI Research noted in a recent report that, indeed, the surging demand we’ve seen since March 9 is–in quite precisely quantifiable ways–historic and last seen in 1982. This is encouraging.
At the beginning of 2009 investors had more dollars stashed in money market funds (cash) than they had in stock mutual funds–a very rare occurrence. For a brief spell last December, 3-month US Treasury bills had a negative yield–meaning that investors were willing to pay the US Government in order to insure a loss–because it was only a slight, predictable loss. This is by far the most extreme level of fear and risk aversion I’ve seen in a career that stretches back to 1980.
The surging demand we’ve seen since March 9 indicates that this mountain of cash–the embodiment of investor fear–has started to move into equities. It signals that the pendulum is beginning to swing, however slightly, away from the extreme of near-total fear and toward the first faint stirrings of an appetite for risk. But even faint stirrings on the part of such vast pent-up demand can spur huge upward moves in stock prices.
Why are investors peeking out of their bunkers? As we noted in our April Outlook, the first “green shoots” of economic stabilization and recovery have begun popping up through the frozen ground of recession.
Consumer spending, which accounts for 70% of US economic activity actually rose 2.2% in the first quarter of 2009 after falling off a cliff last October. Many of the largest US banks are posting solid earnings. Credit is beginning to flow. House sales, ground zero of the financial crisis, are picking up. And all of this is happening before President Obama’s spending stimulus really kicks in.
Taken together, the various early signs of recovery have convinced some investors that the End Times have been indefinitely postponed. And if this is so, then risk assets are cheap, having been priced for Armageddon.
You can count us in the “green shoots” camp. Accordingly, we’ve been gently nudging up our equity exposure and tilting it toward more cyclical sectors of the market (e.g., technology, consumer discretionary). But we’re still keeping a fair amount of our powder dry. For as every gardener knows, even when the crocuses bloom you can still get a nasty freeze or two.