The contrarians love a good chart-to-hell.
After the Great Recession of 2008-09, when famous investment banks evaporated along with the deeds to homes for hundreds of thousands of Americans, the S&P 500 got a shot in the arm. It was a one-two punch of falling interest rates and a Federal Reserve buying up once-toxic mortgage-backed securities. The Fed helped prop up the bond market too, keeping rates in constant decline. Equities were the only place to make money. Bonds were treated like stocks, with fixed income investors giving up on yield and just hoping a bond priced at 101 can one day hit 120. Everything was sky high. That was the story for about nine years.
The U.S. stock market has had only one major correction since a 19% drop in 2011. Since then, this has been one raging bull market.
But if you believe that once the central banks give up on QE, and once interest rates “normalize,” that the equity market retreats to pre-QE levels, then you would likely think the S&P 500 goes to around 1500 points.
Prior to 2008-09, the previous bear market occurred when the dot-com bubble burst and two American Airline jets piloted by terrorists slammed into the Twin Towers in lower Manhattan on Sept. 11, 2001. The S&P 500 fell 49% from a high of around 1510. It took six years to recover before falling again, this time to 666 in intraday trading on March 6, 2009. It was the lowest the S&P 500 had seen since 1996.
The reason for last week’s equity market slide can be traced to the U.S. non-farm payroll report for January, which featured an increase in average earnings growth to 2.9%, the fastest rate since 2009.
Wage inflation spooked the bond markets. The prospect of higher inflation also resulted in the markets pricing in a 0.75% rate hike this year, with the probability of a fourth hike increasing.
The so-called “Powell Put” is thought to be less market-friendly than the “Greenspan-Bernanke-Yellen Put,” which helped push equity valuations to record levels and inflated financial asset prices in general.
Inflation concerns were exacerbated by the unraveling of strategies betting on low equity volatility through ETNs, exchange-traded notes. The rout was partly triggered by the quick run-up in government bond yields, but investors who want to remain upbeat just need to focus on the economic fundamentals, says BlackRock’s chief investment strategist Richard Turnill in his recent market commentary.
Those fundamentals might be changing, by Turnill’s own admission.
A budget deal approved by Congress last week will significantly increase government spending on defense and other items by roughly $300 billion over two years. The big spending bill, together with tax cuts, will widen the federal deficit.
“We could see net Treasury coupon issuance more than doubling this year,” he says.
Bad for U.S. Treasury bonds. The bond market is bigger than the equity market.
Turnill estimates that the combined effect of government spending and corporate tax cuts could add roughly 1% to GDP this year, compared to the 0.8 percentage point they forecast in his last outlook report.
The stronger economy could easily raise inflation expectations and cause the Fed to hike interest rates faster, and that, with central banks unwinding their QE programs, could drive the S&P much lower than it is today. If the bears finally get their day in the sun.
More Info: www.forbes.com
Categories: Money Matters