As we enter the New Year the changing rationale for a continuing
bull market is the supposed long-awaited hand-off from a market dominated by Quantitative
Easing (QE) to one driven by a burst of economic growth. Although the reasons are changing, this will be
the 4th straight year that economists and strategists are looking
for a pick-up in economic strength. In
each of these years the economic results were disappointing, although the
support of QE was enough to propel stocks higher. We think that the economy once again will
grow far more slowly than the consensus believes, and that the overly-strong
sentiment favoring a continuing robust market will prove to be mistaken.
Optimism about stocks is near a fever pitch that has
preceded major market downturns in the past.
In an illuminating statement in the New York Times, columnist James Stewart
recently wrote: “In the many years I’ve been surveying experts for their predictions
for the coming year, I cannot recall another time when optimism about the stock
market, the economy and corporate profits was so widespread.” The Investment Intelligence Survey showed
bullish sentiment among advisors at 60%, even higher than at the 2000 and 2007
highs, with bears at a low of 15%.
In addition, the National Association of Active
Investment Managers points to the highest allocation to stocks since they began
collecting the data in July 2006. The
Hulbert Newsletter Stock Sentiment Index is at its highest level ever, dating
back to January 1996. The data is
supported anecdotally as well. Strategists and economists seem almost unanimously
bullish, and it is hard to find a bear anywhere. Margin debt, too, is at record highs,
exceeding the levels of 2000 and 2007.
History indicates that whenever the overwhelming sentiment toward the
market is extremely bullish or bearish, it is nearly always wrong, and that is
likely to be the case this time as well.
Furthermore, the case for a breakout to a significantly
higher level of economic growth is weaker than it appears. The stronger growth in 3rd quarter
GDP was largely due to inventory accumulation, as may be the case for the 4th
quarter as well, which is also being given a boost by a lower trade balance.
Consumers, accounting for about 70% of GDP, are still not
in good shape, while housing is also weakening.
The pace of income growth is the worst of the recovery period, with real
disposable income up only 0.6% from a year earlier. The labor force was down year-over-year in
both October and November. The
termination of emergency unemployment benefits leaves 1.4 million people with
no income. A lot of the increased
inventories were accounted for by retailers, and was not justified by the tepid
results of the holiday season. According
to ShopperTrak, year-over-year holiday sales rose by the lowest percentage in
four years. Of the last nine years, only
2008 and 2009 were worse. Although hopes
are high for increased spending by business, this is highly correlated with
The housing industry has also turned down. Existing home sales for November were down
year-over-year for the first time in three years. The mortgage purchasing index has been
declining, indicating further weakness ahead, while mortgage rates are rising.
In sum, we think that the pace of economic growth will
once again prove to be disappointing at a time when the market can no longer
count on QE to bail it out. With the
market also significantly overvalued, as we have pointed out in past comments,
the long overdue market downturn may be close at hand.