First Quarter Gains, We Hardly Knew Ya

How is it possible that many of the year-to-date gains for the major indices – excepting the first weeks’ run up – have been all but eliminated? As of last night’s close, the NDX, the SPX, and the Nasdaq are all below the opening weeks’ highs, while the Dow sits just above them. The Russell 2000 is the only stand out, appreciably above its first weeks’ finish. Essentially, the entire year’s performance gains have come from a single week. See these YTD charts for details. 

Not that you would know this from cheerleaders out there, or if you get your financial news exclusively from television. Many (but by no means all) of the financial shows while lauding Q1 returns, have all but ignored this minor issue.

This is not a sign of an especially healthy market. Having nearly all of one’s YTD gains based upon one single week’s performance is atypical in secular bull markets. Prior bull runs have seen a more measured pace, with gains coming gradually over time. Four months worth of performance coming from a mere week or so is typical of a cyclical bull markets within broader secular bear phase. This is more evidence for why this is less likely to be the start of a multi-decade bull market, and more akin to the 1966-1982 period of fits and starts, rallies and sell offs. And it has been nearly 4 years since the last major sell off on the indices.

If our premise is correct, and this is the tail end of a cyclical bull run, then we should be seeing increasing evidence of froth and speculation. And indeed, that is what is occurring, with evidence of increased retail trading activity: Schwab’s daily average has increased from 191,300 trades in Q1 ‘05 to 275,200 Q1 ’06 – a jump of 44%. Chuck’s profit surged 68% in Q1 ‘06, as revenue rose 21%. Ameritrade has already announced that Q1 earnings would exceed the high end of its previously announced range; E-Trade expects to beat numbers on signs "vigorous retail-stock interest." As a group, retail investors have historically not had good timing. Also worth watching: the spate of financial firms (including second tier brokerages) that have gone public: from Cowen & Co. to Thomas Weisel to Ryan Beck Holdings.

We previously mentioned the outperformance
of low quality stocks
; But even within the “better” names (i.e., SP500), we still see speculation. Consider the dividend versus non-dividend payers in the SPX: Q1, 2006, share prices for the 113 companies in the Standard & Poor’s 500-stock index that don’t provide dividends rose 8.58%. And for the 387 that do? The quarterly gains were 5.45% — some 36% lower. Surprising, considering the advantageous tax treatment of dividends under the 2003 tax laws.

The recent sell off is not likely the end of the cyclical bull. Markets hardly make new highs and then roll over. Before this cycle is through, we expect markets to rally again – making an attempt at new highs – and then fail.



Note: This was written on April 17, and emailed on the morning of April 18.

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