Why the stock market rally may continue# Stock
u*n
1 楼
Why has the stock market been rallying during the past five months? In
hindsight, it seems simple. As long as the Fed or any other central bank (
most recently, the Bank of Japan) is printing money, then stocks rally.
As I have been writing in recent months (Read Viewpoints: Will the sweet
spot for stocks continue?), there have been four factors supporting risk
assets since November: the economy, the market's technical condition (or
tape), sentiment, and monetary policy. Until a few weeks ago, the first
three out of these four factors had been losing steam and were at risk of
toppling the market—or so it seemed at the time. But the market never
toppled, because all that seems to matter these days is monetary policy in
the form of QE (quantitative easing).
Economy: losing some momentum
In terms of the economy, some of the high-frequency economic indicators that
I follow have started to roll over, just as they have done in each of the
past three years at around this time. For instance, the weekly ISI economic
diffusion index is losing momentum exactly in tune with a 10–11 month mini
cycle that has been in force for the past three years.
Technicals: unlikely winners and losers
Technically, during the past few months, we had seen a marked loss of
leadership in the market, from copper to the 10-year Treasury yield to the
Shanghai Composite to eurozone banks—at least until a few weeks ago, when
most of these indicators started to improve. And the most unlikely sectors
led the market higher, namely consumer staples, health care, and utilities—
all of which tend to outperform only during market corrections.
Sentiment: Bullishness reigns
Sentimentwise, bullishness reigns supreme. Mutual fund flows have been
strong, sentiment surveys show a lot of complacency, and we are starting to
see magazine covers, such as those of the Economist and Barron’s, tout the
return of the bull market. These are the kinds of indications we sometimes—
but certainly not always—see at market tops.
Why no correction?
So, why didn’t this combination of weakening economic momentum, eroding
technical leadership, and lofty sentiment levels produce the kind of
correction that we experienced in the springs of 2010, 2011, and 2012? In my
view, it’s because during those previous three corrections the Fed was not
printing money. But this time it is printing, and so is the Bank of Japan,
and by the bucketload.
That's the most logical conclusion for why stocks have been able to hold up
so well while other market and economic indicators have corrected. But the
impact of monetary policy doesn't stop here. According to Trevor Greetham,
our asset allocation director, Investment Solutions Group, in London, it
could also explain why the stock market has been led higher by the more
defensive and higher-yielding sectors. It could also explain the disconnect
between the stock market and industrial commodities. Those two asset classes
have been very tightly correlated until last year.
I believe that, to some degree it comes down to the Fed and QE. The Fed has
pushed many investors—who would normally be satisfied being in safe
Treasuries—out the risk curve into higher-yielding, but riskier, securities
. These include corporate bonds, high yield bonds, emerging-market debt, and
bank loans. While these sectors were attractively valued after the 2008
financial crisis, they are now more fully valued, to the point where
investors may have to be satisfied with the prospect of merely clipping
coupons rather than expecting the kinds of robust capital gains that have
been generated in recent years.
So the reach for yield has gone even further, stretching into the higher-
yielding, low-volatility sectors of the stock market, such as consumer
staples, health care, and utilities. This partly explains why the stock
market has been rallying, and why it has been led by these defensive sectors
as opposed to the more traditional cyclical sectors, such as industrials,
tech, and financials.
In a way, the stock market has become less of an economic barometer and more
of an extension of the bond market, driven by the Fed's management of risk-
free assets. This raises the question of what part of the market is still
sensitive to swings in the economy. The answer seems to be commodities,
which have been quite weak lately, consistent with the rolling over of some
of the high-frequency economic indicators mentioned above. This would
explain why industrial metals have stopped correlating to stocks and have
instead fallen out of bed, while the S&P 500® Index and the Dow have
kept on making new highs.
In addition, certain economically sensitive sectors such as industrials and
tech have been lagging, as have certain regions of the global economy,
especially China and emerging markets, as well as Asia ex-Japan in general.
What this tells me is that as long as the Fed and other central banks
continue to flood the system with massive amounts of liquidity, perhaps the
only corrections we’ll experience will be the kinds that take place behind
the scenes and underneath the surface of the major averages. In other words,
the only corrections we’ll experience will be in commodities and in those
regions and sectors that are economically sensitive.
So, maybe the risk-asset party continues for a while longer. What could
ultimately derail the rally? Perhaps it is when the QE music stops, or if
the economy rolls over, or if the Fed or Bank of Japan’s aggressive
monetary medicine backfires by causing higher interest rates or even a
currency war.
hindsight, it seems simple. As long as the Fed or any other central bank (
most recently, the Bank of Japan) is printing money, then stocks rally.
As I have been writing in recent months (Read Viewpoints: Will the sweet
spot for stocks continue?), there have been four factors supporting risk
assets since November: the economy, the market's technical condition (or
tape), sentiment, and monetary policy. Until a few weeks ago, the first
three out of these four factors had been losing steam and were at risk of
toppling the market—or so it seemed at the time. But the market never
toppled, because all that seems to matter these days is monetary policy in
the form of QE (quantitative easing).
Economy: losing some momentum
In terms of the economy, some of the high-frequency economic indicators that
I follow have started to roll over, just as they have done in each of the
past three years at around this time. For instance, the weekly ISI economic
diffusion index is losing momentum exactly in tune with a 10–11 month mini
cycle that has been in force for the past three years.
Technicals: unlikely winners and losers
Technically, during the past few months, we had seen a marked loss of
leadership in the market, from copper to the 10-year Treasury yield to the
Shanghai Composite to eurozone banks—at least until a few weeks ago, when
most of these indicators started to improve. And the most unlikely sectors
led the market higher, namely consumer staples, health care, and utilities—
all of which tend to outperform only during market corrections.
Sentiment: Bullishness reigns
Sentimentwise, bullishness reigns supreme. Mutual fund flows have been
strong, sentiment surveys show a lot of complacency, and we are starting to
see magazine covers, such as those of the Economist and Barron’s, tout the
return of the bull market. These are the kinds of indications we sometimes—
but certainly not always—see at market tops.
Why no correction?
So, why didn’t this combination of weakening economic momentum, eroding
technical leadership, and lofty sentiment levels produce the kind of
correction that we experienced in the springs of 2010, 2011, and 2012? In my
view, it’s because during those previous three corrections the Fed was not
printing money. But this time it is printing, and so is the Bank of Japan,
and by the bucketload.
That's the most logical conclusion for why stocks have been able to hold up
so well while other market and economic indicators have corrected. But the
impact of monetary policy doesn't stop here. According to Trevor Greetham,
our asset allocation director, Investment Solutions Group, in London, it
could also explain why the stock market has been led higher by the more
defensive and higher-yielding sectors. It could also explain the disconnect
between the stock market and industrial commodities. Those two asset classes
have been very tightly correlated until last year.
I believe that, to some degree it comes down to the Fed and QE. The Fed has
pushed many investors—who would normally be satisfied being in safe
Treasuries—out the risk curve into higher-yielding, but riskier, securities
. These include corporate bonds, high yield bonds, emerging-market debt, and
bank loans. While these sectors were attractively valued after the 2008
financial crisis, they are now more fully valued, to the point where
investors may have to be satisfied with the prospect of merely clipping
coupons rather than expecting the kinds of robust capital gains that have
been generated in recent years.
So the reach for yield has gone even further, stretching into the higher-
yielding, low-volatility sectors of the stock market, such as consumer
staples, health care, and utilities. This partly explains why the stock
market has been rallying, and why it has been led by these defensive sectors
as opposed to the more traditional cyclical sectors, such as industrials,
tech, and financials.
In a way, the stock market has become less of an economic barometer and more
of an extension of the bond market, driven by the Fed's management of risk-
free assets. This raises the question of what part of the market is still
sensitive to swings in the economy. The answer seems to be commodities,
which have been quite weak lately, consistent with the rolling over of some
of the high-frequency economic indicators mentioned above. This would
explain why industrial metals have stopped correlating to stocks and have
instead fallen out of bed, while the S&P 500® Index and the Dow have
kept on making new highs.
In addition, certain economically sensitive sectors such as industrials and
tech have been lagging, as have certain regions of the global economy,
especially China and emerging markets, as well as Asia ex-Japan in general.
What this tells me is that as long as the Fed and other central banks
continue to flood the system with massive amounts of liquidity, perhaps the
only corrections we’ll experience will be the kinds that take place behind
the scenes and underneath the surface of the major averages. In other words,
the only corrections we’ll experience will be in commodities and in those
regions and sectors that are economically sensitive.
So, maybe the risk-asset party continues for a while longer. What could
ultimately derail the rally? Perhaps it is when the QE music stops, or if
the economy rolls over, or if the Fed or Bank of Japan’s aggressive
monetary medicine backfires by causing higher interest rates or even a
currency war.
