When does a bull market turn bearish?
This year we will find out whether the economy can grow on its own, says a U.S. analyst who’s not optimistic that the bull market will last
Never assume anything.
We all know what we’d like to see, and we’ve all been told what we might see, but we can never be sure what we actually will see.
Take this quote, for instance. “Some investors draw solace from reports that 2000-2009 was the first calendar year decade in which the S&P 500 had a negative return. They reason that a bad decade must be followed by a good one,” says Mr. Bob Carlson.
“Perhaps, but I suspect sustained positive returns won’t occur until later in the decade.” In short, you can count those chickens now, but you’ll be waiting awhile before they hatch.
Mr. Carlson is a cautious and conservative investor, as the title of his advisory would suggest. Bob Carlson’s Retirement Watch invariably gives its U.S. readers a view of the markets that is free of giddy optimism.
Nor is he deeply pessimistic. He simply views the market from the point of view of someone who believes managing risk is the first principle of sound investing.
In his latest issue, he examines each of the key signs that point to the direction of the market in the months ahead.
The good may outweigh the bad for a time, he says, but there are still many pitfalls out there.
Keeping inflation low
A third of Mr. Carlson’s core Balanced Portfolio is occupied by a single fund that is heavily invested in utilities. That’s a pretty good indication of how cautiously he is approaching the market. He holds no individual stocks in his portfolios.
And this is what makes him careful. “In 2010 we’ll see if the economy is strong enough to grow on its own and if so how much it will grow.”
We all know how much liquidity the U.S. Federal Reserve Board pumped into the system last year. It helped banks and flowed into the investment markets. It certainly explains “the sharp rise in all types of risky assets, including stocks, high-yield bonds, corporate bonds and commodities,” says Mr. Carlson.
But it didn’t do much for the economy. The record levels of unused capacity in production, housing, labour and equipment were reduced somewhat in 2009, but they are still a long way from their peaks.
“The good news is the unused capacity keeps inflation low and is likely to do so for some time.”
Disappointing sales tax
Now the gloves come off. The Fed is scaling back on its purchases of mortgages and bonds, and we will see how strong the economy really is.
The first place to turn for a reading on the economy is consumer confidence. But surveys show it’s still not very high.
In fact, there’s one little-reported source of spending that’s worth noting, Mr. Carlson says. The collection of state sales taxes is “very disappointing.”
Production increased as the recovery began, restoring inventories that were cut too sharply in the panic. “But improvement in employment and production is starting to slow and even reverse in some data,” he reports.
To get the full measure of the market, he looks first at short-term or cyclical indicators. Then he looks at the long-term factors that can tell us whether this is a bear rally or a new bull market.
Momentum favours the bulls
Momentum in the market is clearly in favour of the bulls right now, says Mr. Carlson. Bullishness may be too high, but markets can continue to rise after bullishness reaches high levels, he concedes.
Bond yield spreads are positive and close to normal levels.
And low inflation is historically good for stocks, “except when low inflation becomes deflation.”
These short-term indicators look pretty good for the markets on the whole. But a little farther down the road, things don’t look as promising.
Headwinds will pick up
Low interest rates and a growing money supply are the keys to a long bull market, the editor says. We have those now — but markets do best when rates are falling from high to low, not when they’re at rock bottom.
“More importantly, low rates and a growing money supply are not stimulating new lending and borrowing. The lending and borrowing, not the low rates, are what help the economy.”
Debt levels should be low at the start of a bull market. They conspicuously are not. And consumer demand remains weak.
The stock market is not cheap. Among other things, dividend yields indicate that stocks are expensive. What’s more, investor sentiment is usually pessimistic as a market prepares to take off. It certainly was last March, but it’s downright bullish today.
Not least, there is a lot of talk about the money waiting on the sidelines. But in fact, both individuals and institutions have stock allocations that are only a little below historical levels, says Mr. Carlson.
Tally it all up, says this editor, and we must conclude that 2009 gave us a short-term economic expansion and bull rally. But don’t count on it lasting indefinitely.
“Our best forecast is the first part of 2010 will be okay, but unless private credit growth improves, the headwinds will pick up as 2010 goes on and perhaps earlier.” We cannot assume this will be true, but it’s wise to be ready if it is.
Looking at the very short term, Monday is Family Day in these parts. We’re back on Tuesday.
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