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Last New S&P 500 High Came In May 2015
On May 20, 2015 the S&P 500’s intraday high was 2134. Over a year later, that level has never been exceeded. What does history tell us about markets that fail to make new highs for a long period of time?
77% Of The Cases Ended With A Bear Market
On May 23 the S&P 500 will extend its streak without a record to 253 trading days, matching the drought that lasted through February 1995. Only two other long-term rallies went without new highs for longer — 272 days through 1984 and 361 days through 1961. Bull markets end when a benchmark index falls 20 percent from a record. More often than not, such dry spells are ominous for equities. Among the 13 instances since 1946 that began with stocks going as long as they have now without posting new highs, 10 ended in bear markets.
23% Of The Cases Were Followed By Big Gains
On the bright side, on the three occasions when bull markets survived such slumps, U.S. equities went on to rise 22 percent in the year after a new high was reached. Moreover, the American stock market is usually much farther away from its most recent peak than it is now. On any given day since 1946, the S&P 500 has been about 14 percent from a record, data compiled by Bloomberg show.
Which Way Is The Stock Market Leaning In 2016?
This week’s stock market video reviews the evidence we have in hand in an effort to gain some insight into which way stocks may break in the coming weeks or months.
Inflection Point Periods Require Flexibility
Given the current state of Fed policy/earnings/valuations, it is easy to understand how the big move could come to the downside. However, history tells us that it is possible for long/sideways/frustrating periods in the stock market to be resolved in not only a bullish manner, but an impressive bullish manner. If the bulls are able to push stocks to new highs, the S&P 500 must first make a higher high on a sixty-minute chart, which requires a close this week above 2085.
Video processing should be complete sometime between 7:35 and 8:00 pm ET Friday
A May 16 article outlined the concepts shown below in detail; big moves often come in the stock market after long periods of consolidation.
Normal Retracement Or New Trend?
Is there anything else historically that says a big move may be coming in equities? Yes, the concept of Fibonacci retracements (see chart below). It is normal and to be expected that in the context of an established downtrend to see countertrend moves back to one of the three major Fibonacci retracements (Fibs). So far, in 2016 the sharp rally off the February lows has not exceeded “normal retracement” territory. In this case, retracement refers to the retracement of the down move from point A to point B.
Fibs Help With Bullish and Bearish Odds
Do markets always reverse near the major Fibs? No, Fibs simply help us with probabilities. The weekly chart of the NYSE Composite (2006-2016) below shows a bearish case and a bullish case.
The point of the exercise is that big moves can result once the market decides which way it wants to go near the 61.8% retracement of a large market decline. The bearish move from the 61.8% level in 2008 to the 2009 stock market low was a drop of 56% (a big move). The bullish move between the 61.8% level in 2011-2012 was a gain of 44% (a big move).
How Much Value Can Be Added Or Lost?
The table below puts a 56% drop in perspective based on numerous portfolio sizes.
Conversely, a 44% gain can make a significant contribution to an individual’s nest egg.
Big Move Can Be Up Or Down
The market was on the ropes in early February and righted itself after central banks started throwing spaghetti at the monetary policy wall.
Which way is the market leaning now? As noted in a May 13 video Noticeable Cracks In Bullish Foundation, the market’s current bias is starting to shift back to the concerning side of the bull/bear ledger. However, global central banks are still throwing numerous forms of market-friendly spaghetti to see if anything sticks, as outlined on May 11. Under our approach, we will allocate based on the facts in hand, while remaining open to a big move up (similar to 2012-2015) or a big move down (similar to 2008-2009). The hard data will guide us if we are willing to monitor the markets with a flexible, unbiased, and open mind.
Fed Has A Difficult Job
In terms of government policy, the economy has two primary types of stimulus, fiscal and monetary. The Fed controls monetary policy. Congress is the primary driver of fiscal policy.
In recent years, Congress has left all the heavy lifting to the Fed. Having stated the Fed is in a difficult position, their focus in recent years appears to have shifted almost solely to keeping asset prices propped up, a concept that has not gone unnoticed by the financial markets.
2012 Plan Was To Raise Rates When Unemployment Hit 6.5%
In December 2012, the Federal Reserve provided a 6.5% unemployment target with respect to allowing rates to remain near zero. From USA Today:
The Federal Reserve on Wednesday agreed to keep a key short-term rate near zero until the 7.7% unemployment rate is 6.5% or lower.
Goalpost Taken Down In 2014
The chart below shows the unemployment rate between 2012 and 2016. As you can see, unemployment has been below the Fed’s 6.5% target for some time.
Since it would be a constant source of “why are you still waiting to raise rates” questions, the Fed decided in April 2014 to remove the unemployment goalpost. From CNBC:
The members of the Federal Open Market Committee agreed unanimously in March that a 6.5 percent unemployment target for raising interest rates was “outdated” and should be removed, according to meeting minutes.
The Fed Originally Choose An “Outdated” Target
Rather than face the difficult decision to begin raising interest rates, the Fed kicked the can down the road after calling their own stated unemployment target “outdated”, which begs the question if the target is outdated, then why did the Fed use it in the first place? Did the 6.5% target somehow become outdated between 2012 and 2014?
We Can Afford To Be Patient
In a move that surprised the markets, the Fed stated in March 2015 that it still needed to see more. From the Chicago Tribune:
The Federal Reserve signaled Wednesday that it needs to see further improvement in the job market and higher inflation before it raises interest rates from record lows.
In February 2016, Janet Yellen once again played the “we can be patient” card. From NewsMax:
Federal Reserve Chair Janet Yellen said Tuesday that the U.S. economy is making steady progress, but that for now the Fed is will remain patient about raising interest rates because the job market is still healing and inflation is too low.
Inflation Data Has Been Picking Up
Recent reports have shown inflation is beginning to pick up. In fact, a report released on May 17 said wage growth was the highest in seven years. From Bloomberg:
The median U.S. worker is enjoying their highest wage growth since 2009, according to the Federal Reserve Bank of Atlanta’s wage growth tracker. This metric showed that the median employee saw pay rise 3.4 percent year-over-year as of April, setting a new record for this expansion.
The markets are starting to question the Fed’s stated objectives on unemployment and inflation. From an April 7, 2016 CNBC article:
Inflation in the U.S. has picked up in recent months, toward the top end of Federal Reserve forecasts. While several Fed officials remain focused on building inflationary pressures, Fed Chair Janet Yellen has recently struck a dovish tone, stressing her concerns about global growth and financial conditions as reasons to proceed cautiously with interest-rate hikes.
Trading Volume Has Dropped By 70%
Can markets see the difference between the Fed’s stated/mandated objectives and their actions? If we look at trading volume for the S&P 500 Spider ETF (SPY), the answer seems to be a definitive yes. Three-month average daily volume for SPY for May-July 2010 was 283,000,000 shares. Average daily SPY volume for August-October 2011 was 322,000,000. Current average daily volume for SPY going back three months is just 99,000,000, based on data from Yahoo Finance.
Investors Losing Interest In Centrally-Planned Markets
Trading volume helps us better understand investor interest in a particular market. Using SPY volume, investor interest in the stock market has dropped by almost 70% since 2011. Obviously, there are countless factors impacting investor interest/trading volume, including fundamentals.
Valuations A Concern To Many
When we examine valuations, it is most likely a combination of markets that seemingly get talked up by the Fed every time they begin to fall and extended valuations that have resulted in a sharp decline in investor interest at current S&P 500 levels. According to FactSet, the forward PE ratio for the S&P 500 is higher today than at the 2007 Financial Crisis peak in the stock market.
Low Rates Mean More Debt
The Fed’s seemingly never-ending period of near-zero interest rates has also led to an alarming amount of debt relative to earnings. The tweet below is from FactSet (EBITDA stands for earnings before interest, tax, depreciation and amortization).
Rates Are Too Low
It is not just Fed critics that are waving yellow flags about keeping rates near zero for an extended period. In a recent speech, a voting member of the Fed’s Open Market Committee outlined numerous concerns tied to low rates. From MarketWatch:
Interest rates are too low for today’s economic conditions, creating risks for the outlook, said Kansas City Fed President Esther George on Thursday.“Because monetary policy has a powerful effect on financial conditions, it can give rise to imbalances or capital misallocation that negatively affects longer-run growth,” George said in a speech to business leaders in Albuquerque, New Mexico. Low rates can cause interest-sensitive sectors to take on too much debt and grow quickly, only to unwind in ways that are disruptive, George said, citing the housing crisis and the “current adjustment in the energy sector.” George is a voting member of the Fed’s policy committee. She has dissented at the last two policy meetings in favor of hiking rates.
The Fed has been telling the markets over and over again that the path of interest rates is “data dependent”. The fact that the “data” has been improving relative to the Fed’s own stated objectives and Janet Yellen continues to read from the dovish playbook has not gone unnoticed by seasoned market professionals. From CNBC:
Legendary billionaire investor Stanley Druckenmiller told Sohn Investment Conference attendees to sell their equity holdings Wednesday. The billionaire investor expressed skepticism about the current investment environment due to Federal Reserve’s easy monetary policy and a slowing Chinese economy. “The Fed has borrowed from future consumption more than ever before. It is the least data dependent Fed in history. This is is the longest deviation from historical norms in terms of Fed dovishness than I have ever seen in my career,” Druckenmiller said. “This kind of myopia causes reckless behavior.”
Global Central Banks In Radical Waters
A recent article outlined numerous “are they really doing that” policies being implemented by other central banks around the globe. As noted in a May 2016 video, the Fed’s dual mandate, and more importantly basic economic principles, tell us central banks will try to inflate as long as they possibly can. When inflation starts to become a problem on the high end of the price stability spectrum, it will be much harder for central banks to keep things propped up. Therefore, until the Fed starts to acknowledge inflation, investors must be open to:
Interest Rate Policy Works With A Lag
Even the Fed has acknowledged in the past that it is dangerous to wait until inflation targets are hit before starting to lay the groundwork for keeping longer-term inflation in check. From the Fed’s 2015 Jackson Hole keynote address by Stanley Fischer:
“Because monetary policy influences real activity with a substantial lag, we should not wait until inflation is back to 2% to begin tightening.”
The latest read on inflation was a wage figure that represented the highest wage growth since 2009. Meanwhile, the Fed continues to wait.
What Can We Learn From Last Three Years?
The chart of the NYSE Composite Stock Index below shows equities have been indecisive since the second half of 2013.
The lack of sustained progress in either direction tells us the battle between the bulls and bears has been fairly evenly matched.
1993-1995 Bullish Example
A similar indecisive period took place in the mid-1990s.
Periods of consolidation are often followed by big moves once the market “breaks out of the box”. In the 1993-95 case, the resolution was to the upside.
2006-2008 Bearish Example
A similar period of indecisive investor behavior took place between the fall of 2006 and summer of 2008.
Harder markets are typically followed by easier markets. In the 2006-08 example, the easier market produced a strong and discernible bearish trend.
S&P 500 Moving To 2,340 or 1,680?
This week’s stock market video examines the current period of indecisive investor behavior, including some visuals on what a break to the upside and downside might look like.
Big Moves Can Go Either Way
When we are in a period of long-term consolidation, it often feels like the market will never break from the range. While anything is possible, history says we should have contingency plans in place for a shocking push higher and an alarming crisis-like plunge.
How is it possible the worst ten-day start in U.S. stock market history was followed by what Bloomberg termed the sharpest about face in nine decades? While markets never move based on any one factor, the primary answer is central banks. This article examines the following questions:
- Just how far have central banks gone in their recent attempt to keep asset prices elevated?
- Why are central banks so concerned about keeping things propped up?
- What are the shorter-term investment implications and the potential end game?
- How can we navigate this period of hyper central bank intervention?
Central Banks Are Buying Corporate Stocks And Bonds
In an April 20 article, we chronicled the Federal Reserve’s 26-day interest guidance shift that occurred between January 6 and February 1, 2016. The Fed’s extreme shift on rates fell into the rare category. Central banks across the globe are starting to tread into much more radical policy waters.
Do you think it would be concerning if the Fed announced they were going to start buying S&P 500 ETFs in an effort to “stimulate” the economy? That is exactly what is happening in Japan. From Bloomberg:
They may not realize it yet, but Japan Inc.’s executives are increasingly working for a shareholder unlike any other: the nation’s money-printing central bank. While the Bank of Japan’s name is nowhere to be found in regulatory filings on major stock investors, the monetary authority’s exchange-traded fund purchases have made it a top 10 shareholder in about 90 percent of the Nikkei 225 Stock Average, according to estimates compiled by Bloomberg from public data. It’s now a major owner of more Japanese blue-chips than both BlackRock Inc., the world’s largest money manager, and Vanguard Group, which oversees more than $3 trillion.
Distorting The Sanity Of The Stock Market
While investors prefer to see their investment portfolios rise instead of fall, when government institutions start distorting markets there will eventually be negative consequences. From Bloomberg:
A majority of analysts surveyed by Bloomberg predict the Band of Japan will boost its ETF buying — a move that could come as soon as Thursday. “For those who want shares to go up at any cost, it’s absolutely fantastic that the BOJ is buying so much,” said Shingo Ide, chief equity strategist at NLI Research Institute in Tokyo. “But this is clearly distorting the sanity of the stock market.”
The ECB Will Start Buying Corporate Bonds In June
The “non-traditional” central bank policies have not been limited to Japan. The European Central Bank (ECB) is getting ready to launch a new form of quantitative easing (QE). QE typically involves central banks injecting electronic money into the financial system via the purchase of government debt. However, when central banks start buying corporate debt, they are helping pick winners and losers in the private sector. Some companies will be receiving assistance from the ECB, while others will get no assistance. From Reuters:
The European Central Bank will begin purchases of euro zone corporate bonds in June, ECB President Mario Draghi said on Thursday…The ECB said last month it would start buying corporate bonds issued by companies that are based in the euro zone, have an investment-grade rating and are not banks…The plan has raised questions about the risks the ECB will take onto its balance sheet by buying unsecured private debt.
The Bank of Japan is not only buying publicly traded stocks via ETFs; they recently announced a negative interest rate policy. From CNBC:
The Bank of Japan blindsided global financial markets Friday by adopting negative interest rates for the first time ever, buckling under pressure to revive growth in the world’s third-largest economy…The bank also clearly communicated a dovish bias, with officials saying they would undertake additional easing if necessary using quantitative and qualitative tools, as well as interest rates.
The concept of negative interest rates was described by Bloomberg on March 18:
Imagine a bank that pays negative interest. Depositors are actually charged to keep their money in an account. Crazy as it sounds, several of Europe’s central banks have cut key interest rates below zero and kept them there for more than a year. Now Japan is trying it, too. For some, it’s a bid to reinvigorate an economy with other options exhausted. Others want to push foreigners to move their money somewhere else. Either way, it’s an unorthodox choice that has distorted financial markets and triggered warnings that the strategy could backfire. If negative interest rates work, however, they may mark the start of a new era for the world’s central banks.
Extraordinary Measures Should Only Be Used In Extraordinary Times
Concerns about negative interest rates have been expressed from many corners of the economy and markets. From The Wall Street Journal:
The top two executives at Swiss banking giant UBS Group AG teamed up Tuesday to blast the negative interest rate environment brought on by the easy money policies of central banks, an indication that patience is wearing thin in some quarters over these emergency measures… “The introduction of negative interest rates—now not only in Switzerland, but also in large parts of Europe and in Japan—is an extraordinary measure and should only be used in extraordinary times,” said UBS Chairman Axel Weber in remarks to the bank’s annual shareholders meeting…“We can all only hope that the times of such drastic measures by the central bank pass as quickly as possible,” said Mr. Weber, a former Bundesbank president who has been critical in the past about negative interest rates. “Unfortunately, I have to say, unfortunately, there is little indication that negative interest rates will soon be a thing of the past.”
Why Central Banks Are So Concerned About Keeping Asset Prices Elevated
On December 29, 1989, a massive inflationary bubble began to pop in Japan. As prices dropped, investors with cash sat on their wallets waiting for lower asset prices. The desire to “get out” became much stronger than the desire to “get in” and prices continued to fall. In early 1990, Japan started a process that central bankers have nightmares about – a deflationary spiral. As the chart of the Japanese stock market below shows, a deflationary spiral is very hard to stop once it starts. In fact, over 26 years later the Nikkei is nowhere near its 1989 high.
Can you imagine if the S&P 500 peaked last spring and did not revisit that high for over 26 years? Japan has been desperately trying to reverse deflationary trends. From a 2013 Bloomberg article:
It’s been 22 years since annual inflation in Japan exceeded 2 percent, according to data compiled by Bloomberg. In the last five years of the 1980s, when Japan’s gross domestic product climbed from $1.3 trillion to $3 trillion and the Nikkei 225 Stock Average peaked at almost 39,000, the monthly readings for consumer price gains averaged 1.2 percent, the data show. The Nikkei 225 closed today at 15,407.94. “It’s difficult to say whether we are really exiting deflation,” Mitani said. “Consumer prices are starting to rise, but a large reason for that is based on the weakening yen and rising energy prices. We can’t say that looking at recent results, we have really exited deflation.”
Investment Implications: Artificially High Prices Until Inflation Picks Up
To put some human context around the problems associated with a deflationary spiral, assume you retired in 2015 at age 55. Hypothetically, if the S&P 500 peaked in 2015, similar to the Japanese stock market in 1989, 26 years later you would be 81 years old and the year would be 2041. If you invested $500,000 of your retirement portfolio in the S&P 500 in 2015, it would be worth about $215,000 when you celebrate your 81st birthday in 2041.
The human, social, and political ramifications of such a prolonged deflationary spiral are difficult to imagine. Therefore, given that global central banks may be nearing the end of the traditional “inflate to create the wealth effect” road, it would not be surprising to see even more radical policies in the future, including additional forms of asset purchases (QE) in the United States.
As noted in a May 2016 video, the Fed’s dual mandate, and more importantly basic economic principles, tell us central banks will try to inflate as long as they possibly can. When inflation starts to become a problem on the high end of the price stability spectrum, it will be much harder for central banks to keep things propped up. Therefore, investors must be open to:
- A continuation of extremely dovish and radical policies from global central banks (see article on possible expansion of stock purchases).
- The possibility of asset prices remaining artificially elevated, including the possibility of U.S. markets pushing to new all-time highs.
In his May investment outlook, Bill Gross of Janus Funds summarized the situation this way:
Private banks can fail but a central bank that can print money acceptable to global commerce cannot. I have long argued that this is a Ponzi scheme and it is, yet we are approaching a point of no return with negative interest rates and QE purchases of corporate bonds and stock. Still, I believe that for now central banks will print more helicopter money via QE (perhaps even the U.S. in a year or so) and reluctantly accept their increasingly dependent role in fiscal policy. Investment implications: Prepare for renewed QE from the Fed. Interest rates will stay low for longer, asset prices will continue to be artificially high. At some point, monetary policy will create inflation and markets will be at risk. Not yet, but be careful in the interim.
Tactical Approach Until Fundamentals Overtake Central Banks
There are two main issues that can overtake central bank policies; one we have mentioned, inflation; the other is economic fundamentals. As noted in this video clip, easy-money policies were being implemented by the Fed during both the dot-com bust recession/bear market and 2007-2009 financial crisis, and yet asset prices continued to fall due to overwhelming fundamental issues. The role of inflation in terms of limiting central bank easy-money actions was outlined on May 2.
Data And Charts Can Assist With Bull/Bear Tipping Point
When financial markets determine that rising inflation/weak fundamentals are more important than central bank policies, it will be reflected in all the hard data tracked by our market model. Conversely, if asset-price friendly policies from central banks take precedence over fundamental concerns, it will show up in numerous ways in the hard data, including the possibility of seeing U.S. stocks push to new all-time highs. The data and charts can help us stay more tactical until a clearer long-term trend begins to emerge, as described on May 6.
Fed Will Take Whatever Means Necessary
If you have trouble with the concept of asset prices pushing higher given numerous fundamental concerns (earnings, margins, productivity, valuations, etc.), keep in mind that in a 2002 speech Deflation: Making Sure “It” Doesn’t Happen Here Ben Bernanke reminded us that the Fed would take whatever means necessary to prevent significant deflation in the United States. The Bank Of Japan and European Central Bank have already moved into “whatever means necessary” territory; the Federal Reserve may not be far behind. The relevant blurb from Bernanke’s speech:
The second bulwark against deflation in the United States, and the one that will be the focus of my remarks today, is the Federal Reserve System itself. The Congress has given the Fed the responsibility of preserving price stability (among other objectives), which most definitely implies avoiding deflation as well as inflation. I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States and, moreover, that the U.S. central bank, in cooperation with other parts of the government as needed, has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief.
Fed Does Not Have A Singular Mandate
Given the big miss on the job creation side of Friday’s monthly employment report, it may appear to be easy for the Fed to continue to put off a hike in interest rates. However, the Fed has two primary mandates; full employment and keeping inflation in check. From the Federal Reserve Bank of Chicago’s website:
“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”
Inflation: Glass Half Full
The ratio of Treasury inflation-protected securities (TIP) vs. intermediate-term treasuries (IEF) can be used to monitor inflation expectations. If we use a weekly chart that plots closing prices, you can make an argument that a bullish breakout recently occurred in inflation expectations (see green arrow).
Inflation, Stocks, Bonds, and Commodities
This week’s stock market video examines current inflation expectations in the context of market history/performance of stocks (SPY), bonds (IEF), and commodities (DBC). From The Wall Street Journal:
With the global economy so sluggish, can bond investors rest easy about inflation? Not necessarily. Excluding energy prices, inflation might not be as tame as many think it is.
Inflation: Glass Half Empty
If we use high-low-close bars on the same weekly TIP vs. IEF chart, an argument can be made that we have seen a normal countertrend rally in inflation expectations within the context of an ongoing downtrend. Notice the recent relationship between inflation expectations and the S&P 500 (bottom of chart). We should learn something about the relative attractiveness of stocks, bonds, and commodities based on how inflation expectations evolve over the coming weeks.
Yellen Focused On Wages
If a worker gets a raise, they have more money coming in each month. Therefore, they have more money to spend in the real economy. Thus, inflation expectations, closely watched by the Fed, tend to rise when wages start to rise. From Bloomberg:
Three of the world’s most influential bond investors (Gross, El-Erian, and Kiesel) say the Federal Reserve is still on course to raise interest rates this year…Gross and his peers are warning investors not to count out the Fed after the Labor Department reported U.S. employers added 160,000 workers last month, short of the 200,000 positions projected in a Bloomberg survey of economists. Fed Chair Janet Yellen is also examining earnings, which rose 2.5 percent from a year earlier, more than forecast. Two-year note yields, according to Gross, are too low. “I’m not so sure that June is out,” said Gross, formerly of Pimco and who now runs the Janus Global Unconstrained Bond Fund, speaking on Bloomberg Television May 6. “Yellen, more than jobs, is focused on wages. At 2.5 percent, they’re moving up.”
Economic Data Will Play A Role
If economic and earnings data continue to weaken, it is possible the Fed remains on hold for the remainder of 2016. Under that scenario, bonds (TLT) may be the asset class of choice. The market will be watching Friday’s Producer Price Index release closely for the latest read on inflation.