Since the peak in May, global markets have been bouncing about. There have been various explanations given for these crosscurrents, but few ring true to this seasoned trader. Perhaps we can derive a better explanation as to what this might mean.

Let’s start in Asia, where the Japanese Nikkei Dow 225 has been setting off fireworks. The spectacular run over the past year was caused in large part by changes in the government, especially  the massive fiscal and monetary stimulus put into place by newly elected Prime Minister Shinzo Abe (hence the term Abenomics). On a comparative basis, Japan’s monetary stimulus is three times the size of that in the USA.

The Japanese version of ZIRP/QE sent the Yen plummeting, making Japanese exports that much more attractively priced and goosing profits — and stock prices. Last year at this time, the Nikkei was at 8,300; since then, it has almost doubled to 16,000. The month of May saw the Yen begin to recover a bit, the most likely catalyst for Japan’s recent retreat from its unsustainable market pace. Since the Nikkei’s May 22nd highs, the Nikkei has dropped almost 20%. My best guess is it was simply a case of too far, too fast.

The rest of the Pacific Rim (ex-Japan) fell almost 10% for the month; New Zealand and Australian equity markets were down nearly 13% in May (best guess: fears of slowing imports from China). If we look at the total MSCI World index, it slipped 0.3% for the month.

Here in the US, markets finished up 2.3% in May (including dividends) despite a few ugly Fridays and a big increase in volatility. May started with the Dow at 14,840, ran up to 15,542 before finishing at 15,116. The S&P500 started the month just under 1600, ran to 1680 before closing May at 1631. Gaining over 2.1% in a month doesn’t seem like much – but annualized that’s more than a 25% return, a pace that is clearly unsustainable. Indeed, before the 2nd quarter is even over, US equity markets have tacked on more than 15%. In most full years, investors would be thrilled with those gains; in less than half a year, its simply another case of too much stimulus driving risk assets too far too fast.

As Josh noted, May marked a turning point in how markets are behaving. Regardless of your posture, it is clear that the tone changed significantly.

Whenever we have these pullbacks, even if they appear to be a case of markets simply readjusting to a normal, sustainable pace, I look to look at the market’s Internals — these provide a snapshot of the market’s health. ny_adlIn particular, I track the Advance Decline line, which lets us know the general ratio of advancing versus declining stocks. History has shown us this is very important, as a market that is topping out usually gets led by fewer and fewer names (See Lowry’s Paul Desmond’s work on this). A healthy market is broad, with lots of participation by many equities. We also like to pay attention to the Transports, which helps provide confirmation that the retail, manufacturing and consumption sectors of the overall economy is healthy.

As to the volatility, we know that a 10% correction comes around every once each 2 years, and that we can count on three corrections of 5% over that same time period. We cannot predict these, and have yet to find anyone else who can. We simply accept this as a part of investing, and compose our portfolios with that in mind We also try to make sure that emotionally, we are prepared for these inevitable hiccups.

Last month, I mentioned in our letter to clients  “It would not be a big surprise to us if the markets get a little soft over the next quarter or two.” So far, nothing we see undercuts that view. Given our longer-term perspective, we would rather not make a wild guess as to when this cyclical market is going to end. So far, we see no data supporting the most extreme and negative views.

As such I continue to give this bull market the benefit of the doubt.


Category: Investing, Markets

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

23 Responses to “Is the Cyclical Bull Over Or Is This Just a Pullback?”

  1. neddyj says:

    Art Cashin floated the idea a few weeks back that it’s the spike in yields across Japanese bonds that’s causing an unwinding of the carry trade. Borrow yen cheap, buy risk assets has been working for years…interesting how badly the EMs have gotten pounded of late. If the yen carry trade continues to come unwound and meanwhile we get ‘tapering’ of some sort by our Fed at the same time – it would seem that a rush for the exits from those reducing leverage could cause quite a drop in asset prices. Just the fear of this may keep a cap on our markets for a while…those levered up would sell strength.

    the bull has been handling all of this pretty well actually…it’s wait and see if our markets catch up with the rest of the world on the downside or the rest of the world catches back up to our markets on the upside. So far so good for our markets…though I’d be surprised if our markets only have a 4% pullback while the rest of the world deals with more severe corrections and bear markets, but that’s how this has been playing out so far.

  2. [...] Barry Ritholtz: Contextualizing the recent volatility.  (TBP) [...]

  3. ironman says:

    It’s neither a correction nor a pullback. It would seem to be nothing other than noise….

  4. PeterR says:

    NYSE “Main Engine” may be developing bad breadth IMO. SPY triangle TBD soon by MA(20) and MA(50), plus SPX breadth looks weak also. [charts at link above]

  5. rd says:

    S&P 500 valuations are pretty high right now, but they have run a little longer and further than this in the recent past.

    I think much of the driver for the high valuations has been the low interest rates, so 2% equity dividend yields have been about the same or better than 10-yr T-bond yields. Part of the stock market rise over the past year has been stock puchases in lieu of bonds for income. I don’t think that the stock bull market would survive 3%+ 10-yr T-bond rates unless earnings were really increasing at a healthy clip with rising dividend payouts.

    As a result, the recent S&P gold seal of approval on the US economy and debt is a major worry point as the recent upgrade may have marked the peak of the stock market, given their past history of identifying issues.

  6. Willy2 says:

    Still using the 1974/1975 scenario ? What about the 1929-1933 scenario ?

    • rd says:

      1929-1932 scrunched an entire 15-20 year secular bear market going from peak overvaluation to peak undervaluation into less than 3 years. There was acomplete collapse of confidence everywhere in society in those 3 years that resulted in a sea change on nearly every front, including Glass-Steagal, SEC, Social Security, government employment programs and eventually World War II.

      We had an initial loss of confidence in the stock market in 2000-2002 but it didn’t impact the economy much unlike the 1929-32 feedback loops. Then we got a housing market-financial crisis collapse a few years later that resulted in further deterioration fo the stock market. There is still a lot of confidence in the system – the big question is if we have made it out of this secular bear with just incremental changes.

  7. MayorQuimby says:

    The *price* of equities is not so important to me – what I get for my $ is. Right now I get hardly any growth potential, an under 2% divvy presently and tons of risk. No thank you. Too many people follow the herd, the Fed etc. Money is made by investing in future growth, value and at good prices. The rally might continue and it might not but I’m looking for value outside of US equities going forward.

  8. Hammer of Thor says:

    Is there any point where you would call this a secular bull market, and that it started in March 2009? I understand that it’s FED-driven, but does that change the definition?

    • Yes.

      I am not confident we have hit it yet — my guess is a 30% possibility now

    • rd says:

      My definition for that is simple – when the next bear market has a higher inflation adjusted low than the 2009 bottom. At that point, it is likely that you will have made more money in the S&P 500 than a Lehman Aggregate Index Bond fund form one low to another.

      Until that occurs, it is a series of mini-bulls inside of a long 15-20 year secular bear.

  9. super_trooper says:

    Given changes from 03/2009 until to day. What would be the necessary changes for you to call it a secular bull market? When do you know is THIS is a secular bull market? I don’t care for general rules (analogy ->I am interested in personalized medicine, not treating a large population).

  10. [...] Checking in on the health of the cyclical bull market.  (Big Picture) [...]

  11. According to the Dow Theory, the stock market is close to signaling a primary bear market (cyclical one). If the markets violate the 06/05/2013 lows, the fun is over for the reasons explained here:

  12. sellstop says:

    this “pullback” is less about the Fed and taper and more about the Japanese “bond vigilantes” getting riled up by the prospect of a sudden and intentional devaluation. And the 30yr span of this carry trade means that the effects are widespread in the world markets over that time. The US$ has been artificially supported over the last decades, keeping inflation in this country low and allowing the Fed to pursue the policies that they have pursued. This is about too many big comfortable bets all on the same side of the boat, to mix metaphors….
    And I think it will be the next big thing. The loss of confidence in central banks and their ability to manage finance.
    Time will tell.

  13. sellstop says:

    And I ran into this over on Krastings blog from a couple weeks ago:

  14. [...] a better explanation was what we discussed 10 days ago: Up 16% in the first five and half months of the year is simply to rapid an ascent; we [...]