When I look at the fundamentals that have been the most critical to the current cyclical bull market,
I would have to say the situation is more reminiscent of the post - 1932 Great Depression era than
at any time after WW2. As in the 1930s, the US economy and the stock market were starved for
liquidity, and the Federal Reserve was the primary provider. Thus, the Fed's liquidity activities
as captured by Fed bank credit and the monetary base, were the primary drivers of economic and
stock market recovery as was confidence in the financial system and the economy.
SP 500 profits have rebounded handsomely in a modest economic recovery. Liquidity provided the
raw material for the recovery, and the transmission to higher stock prices has occurred only during
periods when investors knew the Fed was expanding liquidity or was about to. Importantly, a
key measure of confidence -- credit quality spreads -- has exhibited the same behavoir relative
to Fed liquidity as the the stock market has.
Financial system liquidity is showing some improvement excluding the direct effects of Fed
policy, but it has been far too modest to encourage investors. As well, rock bottom short term
interest rates have not been sufficient to cushion the stock markets from steep corrections both
last year and this in the absence of quantitative easing by the Fed. In fact, the full constellation
of core fundamental indicators which underwrote every post WW2 bull market have not
provided a rising market with the stability normally observed.
For now then, quantitative easing or the lack thereof, as well as confidence factors such as
quality spreads, continue to carry the day as far as the stock market is concerned.
Other Important Measures
I watch the trend of the oil price carefully in looking at the stock market. I do not think a rising
oil price bothered stock players very much until it shot up from $85 bl. to $115 earlier this
year when the Libyan insurrection began. It has retraced much of the spike in recent months
and I would rate it as a neutral factor now.
Looking more widely, I keep a weekly cyclical fundamental directional measure. This broad
gauge measure has a forward looking bearing and it has been in a moderate downtrend since
early Apr. of this year. Specifically, it has fallen 11% since then while the market is off about
14.5% from its highs seen earlier in the year. Most of the damage to the weekly fundamental
indicator was done over the early Apr. - mid May interval. Over the past 15 months, the
correlation of the weekly indicator with it weekly SP500 counterpart has been 0.6. It is
also interesting that the strongest positive moves in the fundamental indicator match up well
with the bouts of QE in evidence over the past 2+ years.
Total US business sales and the dollar cost of production have both risen more rapidly than has
the broad measure of financial system liquidity since the economic recovery began. Thus in
effect, the capital markets have been reliant upon the draw down of liquid reserves in the form
of money market funds. Here, the draw down has been $1.1 tril. or 32% from historic high
levels seen in mid 2009, and the current level now stands below readings seen at the prior
market top in 2007. A tidy sum of fire power has already been deployed.
- Peter Richardson
- Retired chief investment officer and former NYSE firm partner with 40 years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!
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