Big Differences Between 1990s Bull Market and This One
The S&P 500 has returned a spectacular 26.2 percent on an average annual basis since bottoming in March 2009, a performance that more or less mimics what happened ahead of the tech-stock bubble that burst in March 2000. The bursting of the tech bubble in 1999 erased more than USD 5 trillion in stock-market value and many market observers see dark parallels between that time and the present.
There are key differences, however. Valuations on the S&P 500 remain around historical averages, even after returning 164 percent since the market hit bottom 50 months ago. Shares trade at around 16 times trailing 12-month profits compared to an average of 25 during the late 1990s. Equity returns this time around have been accompanied by earnings growth, as earnings have surged by about 20 percent per year since 2009, twice as fast as they did during the dot-com advance.
Bears argue that today’s price-to-earnings ratios suggest investors lack confidence in the sustainability of earnings growth and don’t trust this rally. Bulls counter that they imply stocks are valued fairly and have further room to run.
The bulls also have this on their side: the Federal Reserve is providing the economy with an unprecedented level of support. In the late 1990s, the Fed was actively looking to cool the pace of economic growth (GDP growth exceeded 4 percent and inflation was heating up) and raised interest rates six times from 1999 to 2000. By contrast, GDP growth since 2009 has averaged 2 percent annually, and the Fed has kept interest rates near zero percent for the past five years while it has pumped USD 2.3 trillion of economic stimulus into the economy, all in the name of spurring growth.
Also, the rally of the late 1990s was driven largely by individual, as opposed to institutional, investors. Today’s rally has taken place despite individual investors, who have pulled more than USD 400 billion from equity funds over the past four years and have added more than USD 1 trillion to bond funds (in 2013 alone, bond funds through mid-May received more than four times as much money as equity funds).
There’s a lot of scepticism about the state of the US economy and the current stock-market rally. Yet market dynamics today are more conducive to further stock gains than they were in the late 1990s.
End of the Bond Party?
As bonds continue their march upwards, we cannot help but think of the now infamous words spoken by Chuck Prince, then CEO of Citibank, in July 2007: "As long as the music is playing, you've got to get up and dance...We're still dancing." Clearly there are many investors who are approaching the bond market thinking the glass is half full – in reality, there are merely a few drops left in there. Their logic is simple: growth has slowed down (once again), inflation is in check and Japan has now jumped head-first into the quantitative easing party – so keep buying bonds while the music is still playing. The problem is that the music must stop at some point. When it does the effect could be violent.
Central banks around the world have embarked on unprecedented levels of quantitative easing and many believe that this could end in a "ketchup in the bottle effect" – imagine persistently tapping the bottom of a glass ketchup bottle until the ketchup finally bursts out at an unstoppable rate.
Quantitative easing programmes were launched in response to the plummeting of the money multiplier following the financial crisis. If (or when) those programmes succeed, the money multiplier will rise again, resulting in uncontrollably fast monetary growth. At that point, central bankers will have to make the difficult choice between sustaining sharply higher levels of inflation or sacrificing a fledgling recovery. In anticipation of this dilemma, central bankers have been circulating academic papers about the virtues of targeting nominal GDP rather than inflation.
Anyone buying a long-dated bond today is betting on their ability to anticipate ahead of all of the other players in the game when the music will stop. A better path for investors is to reduce interest rate duration and maintain exposure to inflation-linked assets. Commodities and real assets have performed well in inflationary environments historically, and are an integral part of a diversified portfolio. The stakes are high, and who knows how many chairs will be left this time.
Gains in the Brazilian Stock Market
Brazil is no sprinter. The world's eighth-largest economy has grown at a 3.25 percent annual clip since 2000, compared with 2.7 percent for the US and 10 percent for China. Brazil's stock market, however, is up more than 12 percent per year on average over the past 12 years, compared with about 1 percent for the S&P 500 and 5 percent for Hong Kong's Hang Seng Index. Can it continue to race ahead at such a heart-thumping pace? The answer largely depends on three important variables: Brazil's inflation rate, China, and stock valuations.
Inflation in Brazil gets out of control every so often, and it can hammer stocks. Inflation topped 10 percent in 2002, driving equities down by more than 50 percent. The current consensus is for a more moderate 5 percent inflation rate in 2013, so that's not a big worry. But then there's China, the biggest importer of Brazilian commodities. That demand also affects investors because energy and materials account for more than 40 percent of the Brazilian stock market. Right now, the consensus outlook for China GDP is positive, calling for a slight increase next year, to 8.4 percent. Meanwhile, Brazil's stock valuations are reasonable, with a price-earnings ratio of about 11 times 2012 estimated earnings across the MSCI Brazil Index.
Because firstly Brazil's inflation is moderate, secondly China doesn't appear to be on the ropes and thirdly valuations aren't bad, Brazilian stocks may be a good bet now according to some analysts. There are caveats, though, and the biggest one is the global economy, and not just with respect to exports. Brazil could also be vulnerable to investor fear should the global debt crisis worsen. Italo Lombardi, a Latin America economist at Standard Chartered Bank, connected the dots recently when he pointed out that concerns have spread from Greece to Portugal and Spain. "In this scenario," Lombardi said, "risk aversion tends to go up, which affects demand for Brazilian assets in general, including stocks."
Spotlight on the Rise in Japan’s GDP
Japan’s economy expanded the most in a year last quarter as consumer spending and export gains outweighed the weakest business investment since the wake of the March 2011 earthquake and tsunami.
Gross domestic product rose an annualised 3.5 percent, a Cabinet Office release showed in Tokyo. Private consumption, making up 60 percent of GDP, contributed 2.3 percentage points to the jump. Nominal GDP, which is unadjusted for changes in prices, rose 1.5 percent, also the most in a year.
Today’s report shows while consumers, aided by a stock-market surge, are responding to the reflation campaign mounted by Prime Minister Shinzo Abe and Bank of Japan chief Haruhiko Kuroda, companies remain cautious. That may change as the yen’s 20 percent slide against the dollar in the past six months spurs profits and Abe's administration embarks on reducing regulations.
“Japan is clearly back from stagnation last year,” said Naoki Iizuka, an economist at Citigroup Inc. in Tokyo. “The key from here is whether Abe can unveil a strong growth strategy. If he succeeds, that will boost business investment to support growth.” Abe plans next month to unveil his so-called third arrow of structural reform, following the first two arrows of monetary and fiscal stimulus.
Nominal GDP rose 0.4 percent last quarter from the previous three months, less than the median forecast for a 0.5 percent advance. The so-called GDP deflator, a broad measure of prices across the economy, tumbled 1.2 percent from a year before, the most since the final three months of 2011, underscoring Kuroda’s challenge as he seeks to end more than a decade of entrenched deflation.
The Bank of Japan’s plans to double the monetary base, a measure of the supply of money in the economy, have helped the yen weaken more than 15 percent against the dollar and almost 14 percent against the euro this year, the largest declines of the 16 major currencies.
The Nikkei 225 Stock Average (NKY) has climbed almost 45 percent this year, more than twice the gain in the Standard & Poor’s 500 Index. Meantime, bonds have tumbled as inflation expectations have risen. Ten year government bond yields jumped the most in almost a decade until the Bank of Japanannounced a 2.8 trillion yen (USD 27 billion) infusion of funds.
“Some say Japanese stocks may be too high but the GDP shows the strength of economy may justify the uptick trend in stocks,” said Yoshiki Shinke, chief economist at Dai-ichi Life Research Institute. “I see a chance that Japan will have even better growth this quarter.”