Tuesday, November 9, 2010

Taking Out the April High

The broad stock market indexes took out their April highs last week meaning that the bull market that began in March of 2009 is back in business. It has been more than 6 months since the S&P 500 Index hit its April high price of 1217 and then declined on fears that the problems in Greece and other “Club Med” members of the European Union might conspire to throw the U.S. economy, as well as the global economy, into a double dip recession. After finding a bottom on July 2 of this year, the market has rallied by 20% and due to the wonders of negative compounding, a 16% decline followed by a 20% rally gets us back to even. For those that might be wondering, bond investors fared much better from the April top to the current new S&P 500 high set last Friday. The Barclay’s Aggregate Bond Index gained 6.25% while stock investors just eeked out a 1.6% gain including dividends.

Of course bond investors have fared much worse on a relative basis since this cyclical bull market began in March of 2009. The S&P 500 Index including dividends has gained 87% while bonds have rallied by 15%. Finally, it is worth noting that stocks as measured by the S&P 500 Index are still trading 16% below the high set on 10/09/07 including dividends and 21% below the highs without dividends. Bond investors have earned a startling +24% over the same period. Investors are left to ponder what the next twist to this story might be. I have long argued that the S&P 500 Index is now trading in a gigantic range where the top is set at 1530 – 1540 (March of 2000 and October of 2007, respectively) and the bottom is 776 – 676 (October 2002 and March of 2009, respectively). If this is the case, then taking out this April’s high and closing at 1225 last Friday puts us 45% from the low and 25% from the high. It’s clear that the bulls have the upper the hand at the moment and while others will find intermediate points along the way for the market to find resistance to higher prices, the “granddaddy” of price resistance will be found above the 1500 level.

I’ve learned from painful experience that momentum can take financial markets far beyond what fundamental analysis might indicate is fair value. I wouldn’t be surprised at all if we make it all the way back to the top. The problem is that I haven’t been a believer in the underlying case for the bull market so far, and as long as residential real estate prices and massive unemployment continue to be a fact of our economic life, I will remain a skeptic. The Fed fired one of its last remaining bullets last week with a $600 billion plan to buy bonds with printed money, and the election basically ensures that there will be no more fiscal stimulus left to shore up the economy. The stock market is a leading indicator and the message for the past eighteen months is that the economy will expand and so will corporate profits. My ten cents worth is that it will be very hard to get overly bullish here, and that benchmark levels of risk would be just fine with me.