Is Profitibility or Technicals Driving Equity Markets?

I’m not sure I agree with very much in this NYT article, describing the current cyclical bull rally wihtin the longer secular bear market as A Rally That Needs More ‘E’.

“In the first leg of a bull market, when optimism and euphoria are ascendant, investors are willing to bet that the economy will improve and that corporate profit growth is just around the corner. This faith manifests itself not just in rising share prices, but also in rising price-to-earnings ratios.”

I do not believe that this is a) the first leg of a bull market; b) optimism or euphoria are are ascendant; c) investors are betting that the economy is improving.

Rather, this has been a technically driven rally from very deeply oversold conditions. A 6 month, 5,000 point fall will set up the conditions that lead to a massive oversold bounce.

Indeed, the article notes that “the P/E ratio for companies in the Standard & Poor’s 500-stock index has soared 87 percent since this rally began on March 9.” That is not what a typical bull market looks like, and is more accurately described as the reaction to a prior collapse.

“Though conventional wisdom assumes that P/E ratios continue to grow throughout a bull market, that’s not always the case. In fact, it’s rarely the case.”

Well, it may be rare, but it was certainly the situation the 1982-2000 — the greatest bull market of our lifetimes. About 75% of the gains took place due to P/E expansion. The end of that rally (’98-’00) saw P/E rations expand dramatically, especially on the Nasdaq.

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Source:
A Rally That Needs More ‘E’
PAUL J. LIM
NYT November 28, 2009
http://www.nytimes.com/2009/11/29/business/economy/29fund.html

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