Stocktake

STOCKS rallied globally last week following stimulus assurances from Federal Reserve chief Ben Bernanke, although most markets remain well shy of their 2013 highs.

In the US, however, the S&P 500 hit new all-time highs as did the Dow and the small-cap Russell 2000. Even before Bernanke's intervention, the US was already trading in technically overbought territory – of 28 developed markets tracked by Bespoke Investment Group, just two (Japan was the other) were overbought.

Amidst this enthusiasm for all things US, investors are overlooking a historically rich valuation – a cyclically adjusted price-earnings (Cape) ratio of 23, higher than 90 per cent of readings since the 1970s, and one that indicates annual equity gains of just 1 percent over the next decade.

Despite its strong predictive record, Cape has its critics – they argue the indicator is based on earnings that have been artificially depressed over the last decade. Perhaps, but the same could be said of other developed markets, most of which have Cape ratios ranging between 10 and 15 (a number of troubled European countries, including Ireland, have single-digit ratios).

The US may well deserve a valuation gap, but double that of competing indices? Hardly.


Timing is of the essence
THE S&P 500 may have gained 145 per cent since 2009, but ordinary people have missed out. Blackrock last week noted that just 52 percent of people are invested in the stock market – 13 per cent below 2007's record high, and the lowest since Gallup began tracking figures in 1998.

Even for those who are invested, the wealth effect may not be as great as one might think – separate Gallup surveys show people are terrible market-timers. In May, just prior to a 6 per cent market decline, investor optimism hit its highest point in six years, the survey shows. At the market bottom last November, just prior to a swift 25 per cent rally, optimism had sank to its lowest level since early 2009. That 2009 reading had been the lowest on record, so investors were not positioned to benefit from the mammoth rally that ensued. In 2007, of course, optimism was at its highest level in seven years – markets subsequently more than halved.

The highest reading ever? At the height of the dotcom bubble in January 2000, when markets had hit their highest valuation in history and were poised to halve and endure a rare lost decade.


Corrections are rare in bull markets
THE S&P's recent 6 per c ent pullback fell well short of the official definition of a correction – 10 per cent. That entire decline has quickly been erased, frustrating both bears and traders looking to jump on board the bull market. However, as market strategist Ed Yardeni points out, corrections during bull markets are rarer than one might think.

There have been three corrections (declines of 16 per cent, 19 per cent and 10 per cent) since the bull market began in 2009, Yardeni notes. In the previous bull market between late 2002 and 2007, there was just one double-digit decline, and none from 2003 onwards. During the great secular bull market between 1982 and 2000, there were only four corrections, in 1984, 1987, 1990 and 1998.

Market pullbacks are common in bull markets, particularly when sentiment gets frothy, but they tend to be short and shallow. Those looking to buy at bargain levels may have a long wait.

Momentum matters
Talking of bull markets, the Nasdaq last week hit a 12-year high, following an astonishing 12-day winning streak – the longest such run in four years.

What goes up, must come down?

Not in this case. The PastStat.com blog looked at 20 examples of eight-day winning streaks since 2000.

Five days later, the Nasdaq had gained further in 16 instances; 10ten days later, it was up on 14 occasions; there were 17 cases of gains looking 20 days out, and 16 when stretched to 40 days.

Amateur traders and spread-betters often bet on hunches, assuming that extended markets ‘cannot’ go higher or lower.

As the Nasdaq shows, however, it doesn't pay to underestimate momentum.


'Puffery' defence more hot air
INVESTORS know better than to rely on our "puffery", credit rating agency Standard and Poors told a US court last week.

It’s a novel defence by the company, which is being sued by the US justice department for allegedly defrauding investors by giving top ratings to subprime securities in the run-up to the global financial crisis.

The puffery defence is hard to reconcile with adverts the company is currently running, however. “The fact is, we’re proud of our work and the people behind it, and we’ve taken to heart the lessons learned during the financial crisis, improving and refining the methodologies behind our ratings”, the voiceover promises.

More puffery, presumably.