Markets are making 4 and 5 year highs. The noise out of the talking heads has been anything but bearish. Those who listen to all the cheering on the financial channels may be wondering why they are not feeling like their holdings are making new highs. Their statements certainly do not look like the result of a stellar 5 year Bull market run.
Understanding the route we took to get here explains some of it. Over 5 years, this has been a painful round trip, with the market crash continuing to make new lows into October 2002. We nearly revisited those pre-War lows March 2003. Indeed, the bulk of the market gains have come in one year in five: 2003. If you bought equities prior to the war’s start, you were richly rewarded for your risk taking. Meanwhile, longer term “Buy & Hold” investors have suffered lots of agita with very little to show for their troubles.
Looking at the actual numbers reveals why. Going back to the data, we see that the S&P500 was at 1,143 five years ago; It closed at 1,307 Friday. The Nasdaq was at 1,857 five years ago; Yesterday’s close was 2306. The most recent Dow close was 11,280 versus 9,721 five years ago.
Those numbers are annual returns of 2.72% for the SPX, 4.43%, on the Nasdaq, and the Dow generated annual returns of 3.02%. As the nearby chart reveals, this is hardly world beating performance. The exception to this has been the small cap issues; in particular, the strong Russell 2000. After years of under performance, the smaller issues have returned with a vengeance, mean-reverting to annual returns of nearly 11%. That’s about the S&P’s average. One has to wonder, however, when the pendulum will eventually swing back towards the larger cap. (We also note that others have incorrectly predicted this for 5 years running).
Today, Momentum is driving the market, with fundamentals taking a back seat to ever shorter term trading. Long-only managers are starting to get criticized for conservatism, while the shorts have been chased out of town. Liquidity abounds; M&A activity has reached frenzied levels, with plentiful private equity cash driving deals. Today’s WSJ discusses pre-emptive financing – venture capitalists throwing money at risky, untested start-ups. There is hidden leverage behind derivatives and many hedge funds. The Bears have been sent scampering into the woods to lick their wounds and do what it is that bears do in the woods.
Which brings us to this week’s market call: We are hard pressed to find much company as Bears for 2nd half 2006. And we are impressed with how quickly our short term Bullish targets from last week have nearly been achieved: We continue to see those marks – Dow 11,350, SPX, 1,335, and NDX 1,795 – as the upper range of this move, and reiterate our call for cautiousness.
We suspect this market is in the process of topping, as early as this week.