Stocks Upward Bias, Golden Cross, Risk Rising
February 16, 2012
David R. Kotok
Stocks continue to rally in the face of the ongoing Greek tragedy, while rating agencies downgrade sovereigns and warn the banks, and while Congress fiddles as Washington burns. What does the market know that others cannot see?
1. Liquidity-driven rallies are extraordinarily strong. The central banks of the world have increased their balance sheets by trillions, and the short-term interest rate is near zero. If you use the short-term rate to compute an equity risk premium, you get a huge number. Of course, we know that zero is a poor standard. Moreover, we know that it will not last forever. In addition, we believe there will be a penalty to pay for this prolonged period of zero-cost financing. However, while we wait the party continues. It is harder and harder for folks to stay on the sidelines. It is too soon to abandon the bull market.
2. The US stock market aggregate value is above 100% of the US GDP. That is not cheap by historical standards. It is not the highest we have seen. Prior peaks include 170% in 1999 and 120% in 2007. You cannot easily trade stocks on the market cap/GDP ratio. It does not help you time decisions. It does warn you about risky levels. Right now it is only flashing yellow.
3. Many claim the crowd is wrong, and there is now a large crowd in the markets. Ned Davis’ seminal research says otherwise. Bullish crowds can accompany rising markets for long periods of time. As Ned points out in a February 15 missive, “At extremes in sentiment, the crowd is nearly always wrong.” But during the move or trend the crowd can be right for a while. Ned’s measures of bullish extreme have not been reached. They are getting closer.
4. Golden crosses are usually bullish for stocks. Strategas studied them and confirms this view. They studied 43 golden crosses since 1932. Bottom line: when you see a golden cross, you want to be “in” not “out.” We have had one in the S&P500 and in many sectors.
5. Let’s go back to the supply of stocks and the demand for stocks. Ned Davis tracks this in a thoughtfully designed series. When demand exceeds supply, stock prices rise. The statistics are compelling. The reverse is true as well: stocks fall when supply exceeds demand. Right now demand has climbed rapidly. Ned’s research suggests the markets could gain at an annual rate of about 10%, going forward. Of course, past performance is no guarantee, but Ned’s history spans two data sets. One is from 1997 forward. The longer one started in 1981. Both were bullish.
Cumberland continues to be fully invested in our US stock ETF accounts. We continue to overweight energy for all the reasons you read about every day. We like the financials for recovery but favor regional banks and have exited the very large institutions that are under review for credit-rating downgrades. We like small- and mid-cap growth.
We are also watching warily as the political circus unfolds and as the calendar progresses thru the early part of the year when stocks have an historical upward bias.
David R. Kotok, Chairman and Chief Investment Officer