Macroscope
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Why the bull market won’t stop any time soon

PUBLISHED : Wednesday, 08 March, 2017, 9:34am
UPDATED : Wednesday, 08 March, 2017, 10:46pm

The lion roars, the dragon claws, the bull rages rampant, and the bear cowers. Such are likely to be the sentiments coming out of our financial pages for the rest of this year. For the Bull Market is Coming!

A booming rally has been brewing for a while – but bull markets climb a wall of worry. And has the market worried…the Fed, Brexit, oil, the China slowdown, Trump, Le Pen, and a million other things have held investors back from filling their boots. Yet continued positive economic growth helped by central bankers willing to issue free money has led markets to, almost unnoticed, respond with breathtaking rises.

When the red mist of a mature bull market descends, there are few limits to the market’s ability to price in good news

We may remark on the Hang Seng’s rise of 85 per cent from its February 2009 low, but are astounded at the comparable performance of Wall Street. The Dow Jones Industrial Average is up nearly 200 per cent; rising from the 7,000 level to today’s 21,000. Such a rise in a modern sophisticated market is as extraordinary as it is unexpected.

The bull’s charge is accelerating. The red mist is coming down. It took the Dow nearly 100 weeks to rise from 18,000 to the 19,000 index level. It took 10 weeks to rise the thousand points from 19,000 to 20,000; and it took just four to race from 20,000 to 21,000. The bull market is well advanced, for since the market broke 14,000 in February 2013, the thousand-point mark has been beaten roughly every six months or so.

Surely this means that the end is nigh? What goes up must come down; markets are expensive; you never get something for nothing; where is all of this unearned wealth coming from? Well, behavioural finance tells us that when the markets keep on going, they only stop at the top – when the music stops. That point is a lot higher than where we are at the moment.

During the big rise of the middle 2000’s, it was interesting to see young analysts using new methods of valuation, such as cash flow, and earnings before interest, taxes, depreciation and amortisation multiples. Not surprisingly all of these looked cheaper than the simple share price-to-earnings per share ratio valuation multiple. Call me old fashioned, but I always liked PEs. They are blunt but simple, elegant and comparable. New valuation instruments can be both interesting and contrived but little improved on the humble PE.

There will be pullbacks – but for the rest of the year the market is in buy and hold territory

Today’s ‘improvement’ on the PE is CAPE, the cyclically adjusted price-to-earnings ratio. Yet even CAPE shows current markets to be expensive at a ratio of 29; but way off ‘bubble territory’ of between 40 and 50. There is still plenty of headroom left for markets to motor.

When the red mist of a mature bull market descends, there are few limits to the market’s ability to price in good news – all of which can be justified with further analysis. Everybody forgets that the markets can go down as well as up. Bad news is ignored or explained away. In a bull market, moderation does not pay the bills. The picture therefore looks good for the rest of 2017, with a new American president willing to spend, very accommodating monetary conditions (that is, lots of cheap available cash), and a recovering European economy which will brush off its political travails. The bull market is of course unlikely to continue to rise at this pace in the short term. There will be pullbacks – but for the rest of the year the market is in buy and hold territory.

A Great Rotation will take place as investors spend the rest of the year working their way around the market, seeking returns by investing in anything that has not yet moved. That portends the Great Crash. Eventually that final grain of sand, an unknown piece of bad news, will set the unstable mountain sliding.

The picture at the top of the mountain looks very bleak. Global economies still have an enormous debt hangover from the irrational exuberance of the early 2000’s - let alone the deranged borrowing encouraged by irrationally low interest rates inspired by the one-eyed economics of the Federal Reserve.

By definition, we do not know why or when the market will top – if we did, the fall would not be as severe. But those of us who observe history know that it repeats itself; so we will all remember to sell at the right time … won’t we?

Richard Harris is a veteran investment manager, banker, writer, broadcaster and financial expert witness

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