By Michael Santoli
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Investors are studying their financial horoscope for hints about whether the third time will prove a hex or a charm.
Sure, this question hovers over the big picture, as the benchmark Standard & Poor’s 500 has nosed above the 1,550 mark for the third time since first tagging that level in March 2000, and now sits about 1% below its all-time closing peak set in October of 2007.
Yet the more pressing “three-peat” market analogy is the way the 2013 market action has followed along the path carved at the outset of both 2011 and 2012, when a first-quarter rally peaked as Gemini gave way to Aries on the calendar.
[See related piece: Surprise! It's Been a Decent Decade for Stocks]
In each of the past three years, the S&P 500 hustled to a gain of between 6% and 8% by Valentine’s Day, almost in a straight line. The 2011 rally then faltered for a few weeks as Libyan unrest and inklings of a European-debt-flu relapse emerged, before recovering to an April high.
A close resemblance
It’s the 2012 and 2013 versions that most resemble one another. Through Monday’s close, the S&P 500 was up 9.1%, exactly the year-to-date gain as of March 12, 2012. In both years, the CBOE S&P 500 Volatility Index (or VIX) declined by more than 33% between Dec. 31 of the prior year and the March expiration of stock options (which this year comes Friday). The yield on the 10-year Treasury note, meantime, rose both years from beneath 1.90% to a bit more than 2%.
These numbers tell a story of investors coming into a year in a defensive stance, amply hedged and not quite confident that the turn of the calendar would be friendly to stocks. Without offering much chance for the cautious to buy in patiently, the indexes began to lift, the economic data in each year picked up smartly, corporate profits remained solid enough to encourage stock bulls and the speculative sap began to rise.
As B of A Merrill Lynch technical strategist Mary Ann Bartels notes, the advance toward new highs lately has been broad-based and appears sturdy. Yet she adds that the market’s continued levitation above its longer-term trend raises the odds that an ultimate retreat would go deeper than 10%.
No irrational exuberance here
The public is not particularly exuberant toward stocks, uneasily pointing to the Federal Reserve as the main market prop, with no confidence-inspiring “cover story” for the rally at hand similar to the China boom in the mid-2000s and the tech revolution of the late 1990s.
Professional traders, however, have overwhelmingly deferred to the upward trend, it seems, as the percentage of bullish respondents to the Daily Sentiment Index reached heights also seen at the spring 2012 highs.
[See related piece: Dow's New High a Gently Cheered Win for the Defense]
Last year, after the rally stretched a bit higher than the current one has gone, the economic data softened up and a weakened form of the Euro-debt contagion virus surfaced, causing stocks to confound the overly optimistic consensus by rolling over to what ultimately became a nearly 10% correction into June.
There is no way to predict if the pattern of last year and 2011 will repeat, of course. Bulls can take solace in the fact that the market doesn’t tend to accommodate the pattern-spotters by following the same script three times in a row. And, of course, the market has undergone these annual gut checks at successively higher levels each time.
Companies are recycling tens of billions toward buying their own shares, compressed volatility increases risk appetites and the process of pressuring companies to liberate untapped corporate value is well underway.
This is the sort of activity that helps drive the latter phases of a bull market, and if we are to see a period of broad public exuberance before the bull expires, we’re not there yet. Sam Stovall of S&P Capital IQ has been vocal in describing how the fifth year of a bull market tends historically to deliver big gains.
And then there's the Fed
Then there’s the Fed. The Federal Reserve’s asset-buying campaign, or QE3, is in place indefinitely, as a more limited QE2 was underway a year ago. This, undoubtedly, is a supportive factor. But not in the unique, direct way that many market observers insist it is.
An accommodative Fed has been a feature of almost every bull market for decades. And the current quantitative easing program was well in place when stocks tumbled 7% last fall, so its existence promises no immunity from sharp setbacks.
What the Fed is doing is altering the prices of financial assets that over time come to be valued against one another. Most relevant is the way stocks are valued versus corporate debt – specifically the high-yield debt of riskier corporate buyers, the class of securities that sits adjacent to stocks on the risk spectrum. High-yield debt now brings in an average of 5.66%, says the credit-strategy group at RBS, compared to 7.05% one year ago.
Expressed another way, the “price-earnings ratio” of high yield today is 17.6-times (100 divided by 5.66), compared to 14.2 a year ago. Quite neatly, the trailing P/E ratio on reported profits for the S&P 500 index is also up by more than two multiple points in the past year, to 17.9-times from 15.7-times a year.
Sean Darby, global equity strategist at Jefferies, lifted his 2013 target for the S&P 500 to 1,673 from 1,565 Tuesday, while noting: “The main risk to our view is an unwinding of corporate credit spreads and a change in the pace of monetary expansion. While we acknowledge that the economy is a ‘work in progress’ and equity valuations are trading slightly above fair value, the improvement in the earnings picture coupled with subdued bond yields ought to allow equity prices more room to inflate.”
This is a plausible scenario, and can proceed for some time to come if no economic stumble or financial accident comes along to disturb it. Yet it also makes explicit that stocks can only be cast as truly attractive by comparing them to things that most consider unduly expensive.
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