Thursday, November 7, 2013

Placing the Current Bull Market In Perspective

The current cyclical bull market is now second largest and third longest of the last 80 years. The current gain is twice the average for a cyclical bull market, and its length is almost 2 1/2 times the average.

The bull market of the 1990s (first on the list) is clearly in a completely different league; this is a theme throughout this post (data from Ned Davis).

As the data above shows, the rate of gain in the current bull market is among the highest ever. Since the end of 2012, the slope of ascent has become even steeper. This is similar to mid-2006 to mid-2007 (arrows).

How strong is the current trend? SPX has now closed above its 200-day moving average for 244 consecutive days. This is similar to the 2004-07 run referenced above. Again, the 1990s were in a different league (data from John Kicklighter).

SPX has gone 77 weeks without a 3-week losing streak. This is the third longest streak of the past 40 years. Only April 1987 (81 weeks) and July 1996 (107 weeks) were longer. Again, the 1990s take the prize (data from Ryan Detrick here).

Retail investors equity allocations reached a 6-year high (September 2007) this month. At 66%, it is less than 4 percentage points shy of the peaks reached during 2004 to 2007. Not surprisingly, the 1990s peaked above 75%. Current cash allocations are, on the other hand, below 2004 to 2007 levels and at similar levels to the 1990s (data from AAII and Orcam).

Below is another look at retail investors' cash levels, which are under 0.3 for just the fourth time since 2001. In other words, they have low cash on the sidelines at present (data from Sentimentrader).

So far in 2013, investors have put $277b into stock mutual funds and ETFs. This is the most since 2000. And there are still two more months to go in the year (data from Trim Tabs).

How do their holdings compare with the past? Households ownership of equities plus mutual funds is as large now as it has been at any time in the past with the exception of the late 1990s (data from Goldman Sachs).

Now let's look at fund managers. Fund managers were underweight equities in mid-2012, before the rate ascent in SPX accelerated. Last month, their equity allocation was the second highest since 2001; higher, in fact, than in late 2007 (data from BAML and Short Side of Long).

90% of fund managers are bullish on large cap stocks. 90% are bearish on treasuries (data from Barron's).

Investment advisors are the most bullish and the least bearish since April 2011. Remarkably, they are now more net bullish than at any time during 2004 to 2007 (data from Investor's Intelligence and Short Side of Long).

NYSE margin debt relative to the inflation adjusted SPX is higher than it was in the 1990s (green box). It is about 5% shy of the 2007 top in SPX (yellow lines). In any case, the big picture is that investors are at their most confident and comfortable relative to history (data from Doug Short).

Not all investors are bullish, however. Retail investors ('private client') have been net buyers of equities while institutions have been very large net sellers (data from BAML).

In fact, retail and institutional investors have strongly divergent opinions on equities at present; retail is very bullish while institutions are not (data from Sentimentrader).

Why would retail and institutional investors have such divergent views?

After the long and steep push higher in equity prices, the market capitalization of US stocks relative to GDP is the top 96th percentile since WWII.  The 1990s were clearly a completely different period.

The subsequent annual returns in SPX from a valuation at this level has been negative (data from Doug Short).

The same is true when looked at on a cyclically adjusted price-earnings basis. The current valuation is 25x and in the top 90th percentile of the last 140 years. Note, again, that the 1990s are an outlier and probably not a useful benchmark.

The subsequent returns over periods of time longer than a year are negative (data from Robert Shiller and Meb Faber).

Benchmarking equity yields relative to bond yields tells tells a similar tale. The gap is wider now than during most of the 1990s bull market (data from BAML and David Schawel).

US valuations are particularly extreme relative to non-US stocks. US non-financial stocks now trade at a 45% premium to non-US stocks on a price-to-book basis. This is the richest spread in valuations in 12 years and well above the historical premium of 30% (data from Credit Suisse).

Institutions might also be looking at earnings growth, and see two worries.

The first is that organic growth is low. Out of the 390 SPX firms that have reported 3Q financial results, 20 have 13% y-o-y sales growth in 3Q; the other 370 firms have 2% sales growth. The difference between these two groups is that the top 20 have grown through M&A. In other words, organic sales growth, like GDP, is 2% (data from Goldman Sachs).

The other worry looking forward is margin contraction. Current US margins are at a (extreme) high (data from BAML).

Yet this is due to non-operating gains in interest expense and taxes, without which margins are contracting.   According to Stephanie Pomboy, 60% of earnings growth since 2009 has come from reduced interest expense. For the time being, interest rates appear to have bottomed and are rising. All things equal, this will pressure margins (data from Citibank).

What to expect next? According to Wall Street, the steep rate of ascent in SPX will continue in 2014 and 2015 (data from Goldman Sachs).

This would really be remarkable. The Dow has now advanced 5 years in a row (including 2013). Since 1900, it has achieved this accomplishment just 3 times before (1929, 1990, 1996). If it advances again in 2014, it will be only the second time ever. The only other time? The 1990's, of course (here).