From March 2009 to April 2010 the S&P went from 700 to 1,200
without a meaningful correction (10% or greater decline). In the
summer of 2009, as most investors stood on the sidelines watching,
befuddled by the strong rise to S&P 1,000 from the depths of
near economic collapse, I started calling it "the bull train you
My logic was part of the behavioral analysis I use to describe the
nature of equity markets and what institutional investors are most
likely to do in different economic scenarios.
This particular scenario was the highly-probable end of the credit
crisis-driven recession and a dramatic trough in earnings --
especially with the Fed backstopping the banking system and fueling
liquidity with its first round of quantitative easing (QE). This
meant that earnings would accelerate faster than P/E multiples
And this in turn meant that portfolio managers (PMs) had to buy
stocks, or face getting left behind by a train that wouldn't come
back to get them.
I also coined a phrase to describe what was happening between the
economy, earnings, and PMs crafting valuations for companies: the
V-recovery spread. The "spread" was the one between trough earnings
and elevated P/E multiples at the recession bottom.
This was meant to imply that the markets could foresee a rapid
recovery in corporate profits that would outpace the rise in
PMs had to buy this spread
. In other words, they had to put their money on the spread closing
or risk underperforming the market and their peers.
And all this in turn would fuel optimism and economic activity in a
virtuous, upward cycle, a "bootstrap" recovery if you will (which
is what I started calling it on TV appearances in June of 2009).
If I had to draw you a simple picture of the phenomenon, below is
what it might look like...
I'm sure you could build a more fundamentally accurate graph with
actual data fed from a spreadsheet over some time series, or go to
FRED (St. Louis Federal Reserve Economic Data website) and conjure
lots of different data sets to display the theory.
Since I am a trader and a macro strategist, not an economist, I
just look at the big picture to get an idea of the forces at work.
And this is not a quantifiable "spread" as much as it is a "gap"
that tends to close and make equity fund managers buyers of stocks.
While it might be conventional wisdom to think of recessions and
bear markets as having low market multiples, actually in a great
earnings contraction (or the "Great-est" ever as we saw three years
ago) the P/E on the S&P could creep higher than the expansion
Different measures of P/E (e.g., the Schiller "P/E 10") and
different time windows would produce various results. But you get
the basic idea with this broad stroke. While many were still very
skeptical of the possibility of a V-recovery in the economy and
earnings, I told them it was happening right before their eyes and
that it was sustainable because of three things:
1) Emerging Markets were not derailed by our credit crisis and
China was still a super engine of growth. Caterpillar (
) was my go to example and my barometer here.
2) The Fed's QE policies were a floor under the economy because
Bernanke was not about to see us turn into Japan.
3) Fund managers had to buy stocks.
Have we exhausted this self-reinforcing feedback loop now that the
global economy is dealing with Europe in crisis and China slowing
down? Not according to the market and recent economic data.
Will the virtuous cycle slow down? It already has, especially after
the dismal 2011 first-half GDP and the second half meltdown. And
since China has reversed course back to over-stimulating, Europe is
stable in the ICU, other Emerging Markets are recovering, and the
Fed is indefinitely on hold, the growth is likely to surprise those
who believe a painful debt cleansing is the preferred path to
Prepare for Upside Surprises
I've been saying here since November that I think the market and
economy are poised for upside surprises. I still believe that.
While most economists and PMs have put a GDP growth rate of sub-2%
into their earnings models, the market sits patiently above S&P
1,300 "waiting to go higher." That's why I think this pause, which
everyone doubts is an opportunity, is "the bull train we can still
buy." And that doubt will feed the next surge as much as anything.
Oh, that last paragraph is what I wrote last Thursday to Tactical
Trader subscribers before we got a huge surprise in the BLS jobs
data with an addition of 243,000 to non-farm payrolls. Just one of
the many surprises that await us in this economy.
So when a bull like me says I'd love a 5-10% pullback to "buy with
both hands," know that I am not alone. Which means it won't come
until we least suspect it. Remember, markets are just rational
enough to fool the most people.
A highly likely scenario then for the next few weeks is that a push
above S&P 1,350 will suck lots of investors in, and then turn
around and wash them out in a fear-driven dip to 1,275. It should
take several tries over the next few months for the market to get
convincingly through S&P 1,350. We can only hope...
Here's a video I made Wednesday on my use of technical and
behavioral analysis in markets. It's a little long (I should have
done it in two parts) but the first 5 minutes will show you a
handful of assumptions and very simple rules & tools I have
used successfully for years to time swings in the broad market --
and they proved very profitable recently when I sold the S&P at
1,350 in May and bought it back in September at 1,100, and then in
October through December when I said "buy cause we're going to
S&P Chart Reading 101
Kevin Cook is a Senior Stock Strategist with
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