Market View - October 2013

“This time is different” is one of the best known adages in stock market parlance and indeed was the title of a New York Times bestseller published during the depths of the credit crunch bear market in 2009 by renowned economists Carmen Reinhart and Kenneth Rogoff.

By the 9th March 2009, the S&P 500 index in the US had plunged 56.8% to a level of just 676 from its pre Lehman high of 1565 on the 9th October 2007, and many commentators were convinced it would fall further and maybe even replicate the 1930’s depression stock market performance when the US market fell almost 90% over the three years following the initial crash in March 1929. However the combined effect from America’s central bank, the Federal Reserve System (Fed) of its first Quantitative Easing (QE) measure and zero interest rate policy (ZIRP) enacted in late 2008 helped steady the markets and although the S&P 500 continued to fall for the next several weeks following these actions, it soon became apparent the likely positive impact these combined stimuli would have on equities, which signalled the commencement of the long bull market in stocks which continues to this day.

Since the 9th March 2009, the S&P 500 as at end September has climbed more than 150% (having at one point been up more than 155%), including a gain of more than 18% in 2013, with the index currently around 1700. Just as importantly most other major equity market indices have also enjoyed a four and a half year bull market including the FTSE 100 in the UK, which recently was up more than 93% since March 2009, which includes a gain of more than 10% during the first three quarters of 2013.

Elsewhere during 2013 thus far, encouraging returns have been experienced in Europe with the CAC40 in France up almost 15%, and the DAX in Germany gaining 10%, while the Nikkei index in Japan has been the star performer up more than 40%! Meanwhile disappointing relative returns have emanated from the emerging Asian giants of China and India with the Hang Seng up 2.43% this year, the BSE Sensex up just 1.55% and the Shanghai Composite down almost 5%.

The big question with respect to the four and a half year bull market in developed market stocks is whether it can continue, and if so for how much longer and further? Equally important is the question as to whether March 9th 2009 saw the commencement of a new secular bull market as some commentators have suggested, or whether it has simply been a rewarding cyclical bull within a continuing secular bear market that began following the collapse of the tech bubble in the summer of 2000?

Many argue that since the nominal value of the S&P 500 has this year exceeded that of the summer of 2000 by around 10%, March 2009 must inevitably have marked the commencement of a new secular bull market. However two counter arguments suggest the likelihood of it being otherwise, namely the real inflation adjusted level of the market highs in 2013, together with the (artificial?) impact of the unprecedented stimuli injections from the Fed.

In real terms the S&P 500 remains almost 20% below the level it achieved in March 2000 (the peak of the long secular equity bull market that began in 1982), while additionally the reversal of each correction within the current bull market since March 2009 appears to be highly correlated with announcements from the Fed of further stimulus (e.g. QE2 during the 16% market correction of the summer of 2010, Operation Twist during the almost 20% market setback in the spring of 2011 etc.), and indeed this correlation seemed to be confirmed by the reaction of both the US equity and government bond markets in May of this year when the Fed first suggested it would begin “tapering” its current $85 billion per month bond purchases this autumn.

The impact from the announcement of the likely reduction in QE via tapering, and supposed eventual total withdrawal was dramatic, and ironically felt most acutely by the collapse in the equity, bond and currency markets of emerging economies, confirming the suspected correlation between the Washington printing press and the artificial bubble like inflation of these markets. When the September Federal Open Market Committee (FOMC) meeting from the Fed came with the surprise announcement that tapering would not commence this autumn (as originally suggested) after all, global markets breathed a huge sigh of relief and recovered some of their losses as it appeared “risk on” was the order of the day once more.

Unfortunately, as a number of Fed critics observed, official policy now appears to be in disarray with the central bank’s credibility in question, and its balance sheet (currently $3 trillion) continuing to expand alarmingly at a trillion dollars per annum. Just as worryingly the number of real jobs created during the past five years depending upon how you interpret the Bureau of Labor Statistics (BLS) data appear to have barely changed at all!

An article in The Economist newspaper in September titled “The missing millions – Rising disability claims may explain America’s shrinking labour force” suggests that while the official unemployment rate has dropped from more than 10% in 2009 to 7.3% in 2013, few if any of these supposed newly employed 2.7% have actually joined the labour market. Instead it appears most now account for the 2.6 million additional disability insurance claimants on America’s books compared to 2007!

Sadly the unemployment data and other disappointing facts about the American economy on Main Street since the great recession of 2008 are difficult to refute despite the Wall Street stock market boom, especially as the policies used to combat the deflationary impact of the sub-prime banking crisis means global debt is even worse than it was five years ago, with the added concern that global emerging power China now also appears to be faltering under the weight of its own shadow banking liabilities. Just as worryingly in business cycle terms, the developed West is due soon to enter another down phase when it has barely made any economic progress since the last recession!

Consequently while optimism springs eternal as ever within markets, the likelihood is that this time is NOT different to any other occasion when policymakers have tried unsuccessfully to conquer market and economic cycles! Accordingly, while global equity markets can most definitely continue to climb by dint of the stimulation provided by the wonder drug of QE, we must be wary of the inevitable law of diminishing returns, as valuations in the US become increasingly more and more detached from fundamental reality.

On the plus side equity market valuations in the UK appear reasonable by historical measures, and are at bargain basement levels in many European stocks due to the ongoing Euro concerns which, were they to be resolved, could see a dramatic positive rerating overnight! Accordingly we continue to perceive equities as the most attractive major asset class, and continue to advocate focusing upon higher yielding stocks while the global recovery remains fragile and prone to political or black swan setbacks.

The importance of yield within portfolios has been highlighted again recently in research by Ibbotson Associates which showed that 43% of the S&P 500’s return of 394% between 1990 and 2010 came from dividends. In another study from Ned Davis Research between 1972 and 2004, it was found that companies which paid dividends consistently outperformed those which did not.

Dividend paying stocks returned on average 10.1% per annum over the period resulting in $100 invested at outset becoming $2,368 or twenty three times the original amount. A similar investment in companies that did not pay dividends returned just $395, or less than four times the original sum!

Copyright © Ash-Ridge Asset Management 1st October 2013