The positive momentum continued to push the S&P500 higher in the first week of 2010. The index rose 2.7% this week. Complacency in the equity markets also rose; the VIX (or fear) index fell to its lowest level in more than a year.
Yet, as prices pushed higher, the economic data took a turn for the worse. Construction spending was lower than expected. ISM Manufacturing was better than estimated; ISM Non-Manufacturing was lower. Pending home sales took a nosedive, falling 16% month-on-month. Jobless claims were slightly better than forecast, yet continuous claims (when combined with extended and emergency claims) reached all time highs of 11.3 million. Non-farm payrolls stunned forecasters by dropping 85,000 jobs, when they called for an increase of 10,000 jobs. The headline unemployment rate remained unchanged, but only because 661,000 discouraged job-seekers left the workforce; had they continued looking, the unemployment rate would have jumped to about 10.5%. More alarmingly, the percentage of unemployed who’ve been out of work (and looking) for more than 27 weeks soared to 40%, an all-time record. Only 20% a year ago, this figure shows how deeply rooted the unemployment problem has become; the longer folks remain jobless, the more likely they will never find comparable work again. Finally, consumer credit fell by a shocking $17.5 billion last month; analysts were calling for only a $5 billion drop. Clearly, the economy cannot recover on its own if consumers (who make up 70% of GDP) are slashing their means (credit) of consuming.
But in spite of the gloomy economic picture, the equity markets continue to melt upward. Could this be the beginning of a secular bull market, one that lasts for 15 – 20 years?
David Rosenberg, of Gluskin Sheff and formerly Merrill Lynch, used simple historical analysis to answer this question. He measured key metrics at prior secular bull market inceptions. Then he measured these same metrics at the start of the equity market run up in March 2009. If these metrics, in both former and current periods, were roughly the same, then he could safely conclude that a new secular bull market has begun.
David zeroed in on the most recent secular bull market that began in 1982. Here are his findings:
Fed funds rate: Then–18% and can only fall. Now–0% and can only rise.
10 year yield: Then–15% and falling. Now–3.8% and rising.
Budget deficit: Then–3% and improving. Now–10% and not improving.
Household debt to income: Then–62% and rising. Now–123% and falling.
Inflation rate: Then–10% and falling. Now–0% and rising.
Savings rate: Then–10% and falling. Now–4% and rising.
Unemployment: Then–10.8% and falling. Now–10% and rising.
Highest tax rate: Then–69% and falling. Now–35% and rising.
Global trade barriers: Then–high but falling. Now–low but rising.
Corporate profits: Then–6% with room to rise. Now–10% and not rising.
P/E ratio (1 year trailing) for S&P500: Then–8.0x. Now–20.0x
Price-to-book for S&P500: Then–1.0x. Now–2.2x
Dividend yield for S&P500: Then–6.0%. Now–2.0%
Demographics: Then–young workforce investing. Now–old workforce spending.
Put it all together and you get a dramatically different picture in 2009 than you did in 1982. And the picture is not positive. Unlike the equity markets in 1982, the equity markets in 2009 are not only NOT in a secular bull market, but they are most likely OVERVALUED.
If anything, this picture looks like a sign with the warning: “Danger Ahead”.