We made all-time closing highs, but how much is left in this 4.5 month old bull?
Stocks are trading at the highest levels in history. As far as the market is concerned, the Great Recession is ancient history and it’s embracing the expected recovery. Volume remains chronically low since we broke above 1550 three-weeks ago, showing a lack of engagement by both bulls and bears. Thursday’s all-time closing high was a momentous achievement and time will tell if this was the start of the end, or just another step in the steady march higher.
The next significant milestone is 1576, the all-time intraday high set in late 2007. We are seven-points shy of this target and in easy striking distance if buyers support this breakout. The other noteworthy event is the end of the first quarter. Big money managers closed their books on Thursday and are starting fresh Monday. Will they pursue the same strategy from Q1, or shift gears?
The rally that Ben built. It seems everyone knows the Fed created this invincible market and “don’t fight the Fed” is the rallying cry of bulls. But as readers of this blog know, only two things move markets, supply and demand. Stock certificates are like baseball cards and primarily derive their value from what other people are willing to pay for them. The only real tool the Fed has is indirectly influencing interest rates and they have been successful at driving them to historic lows. Low interest rates make it less expensive for businesses and individuals to borrow money, but this also make it less attractive to invest in safe, fixed-income instruments. The pathetic interest rate on Treasuries and savings accounts persuaded many to search for return in riskier assets, and to a large degree this worked as the stock market has been a large beneficiary.
Last year there was concern about diminishing returns and inflation from QE3 and QEfinity, but the market continued rallying and inflation remains constrained. Some will point to rising prices at the grocery story as proof of inflation, but to have real inflation we also need wage inflation, and given the employment situation, it seems unlikely we will experience runaway inflation any time soon. While we might experience a decrease in standard of living as the dollar falls and we compete with an exploding global middle-class for resources and products, that is completely different from out of control inflation.
But back to the markets, easy money has propped up the stocks, but now everyone expects it to keep working, will it? Going back to the supply and demand argument, where are the next buyers coming from? Some point to an over-inflated bond market, but most bond holders are not in bonds for profit, but security. After 2008 ROI has a new meaning, Return OF Investment. Many investors saw their retirement plans shatter over a period of months and it will take many years to recover from that trauma. The eventual move out of bonds into equities will happen at a glacial pace and while it will provide lift to the secular bull market, it is not enough to overcome intermediate market weakness.
The current rally is 4.5 months old, fueled by a nearly nonstop wave of buying since the November lows. The question any bull needs to answer is who is the next buyer? Everyone trusts Uncle Ben’s safety net and is buying with little regard to the risks, but if everyone is in, who is left to buy? Its been a long time since the markets felt this safe, making it one of the most dangerous time in years.
The easy money has already been made. Any profits going forward will be hard fought and involve some gut wrenching volatility. Every rally leg eventually comes to an end and given the size of the September’s modest selloff and recent rebound, this rally has come a long way. Given the recent strength, we should be looking for places to lock in profits not initiate or add to positions.
Momentum is clearly higher, and shorting the market here is picking a top, but there is a huge difference in risk/reward between locking in profits and going short. The market could top on Monday, next week, or next month. The truth is no one knows exactly when the market will top, but we can identify situations where it is more likely to top. The key to success in the markets is not selling too soon and not holding too long. Given we are 4.5 months into this, that doesn’t seem too soon, and holding for more gains is pushing our luck. If we were to pick the sweet spot between too quick and too long, this seems to be it.
The market has experienced year-long rallies before, the most recent following 2009’s generational market bottom. But we have to ask ourselves if the events leading up to March 2009 bottom are materially different from our most recent November 2012 lows? Is there anything in common between the two?
Markets often act like springs, the harder we push one way, the bigger the reaction in the opposite direction will be. We see major moves following crashes and euphoric bubbles, but current conditions don’t conform to these extreme scenarios, so more likely this rally will be of the vanilla verity. 6-months is not out of the question, meaning we could have another few weeks of upside left and that is what we have to watch for. Continued support above 1560 next week shows the market can still find buyers and will likely continue higher. The thing we need to be most careful of is weakness that doesn’t bounce back. There are only so many time dip-buyers can prop up the market and we are testing that limit.