Stock markets – secondary or primary bull?
Ever since Richard Russell (Dow Theory Letters) called a “Dow Theory bull signal” last Thursday, the debate has been rekindled as to whether the US stock markets are experiencing a primary (secular) bull market or a rally within a primary bear market, i.e. a secondary or so-called cyclical bull phase.
As mentioned previously, Russell views the March 9 low as a secondary low, saying: “We are now in a cyclical bull market as opposed to a secular or primary bull market. In effect, we’re in an extended bear market rally. The true bear market bottom lies somewhere ahead.”
As always, there are various signals pointing in different directions. The 200-day moving average of the S&P 500 Index just three days ago turned up for the first time since January 2008, after having been breached upwards by the Index in early June. The 200-day line is generally seen as a key indicator distinguishing between a primary bull and bear market.
Also, when considering monthly data, three momentum-type oscillators (RSI, MACD and ROC) are reversing course for the first time since the sell signals of 2007 and now either indicate buy signals (or are getting close to a signal in the case of MACD).
Amid the uncertainty, the highly rated Ned Davis (Ned Davis Research) has just completed a research project in which he identified seven dimensions one could use to compare the March 9 low with secular lows of the past. His findings, as reported by Mark Hulbert on MarketWatch (hat tip: The Big Picture), were as follows.
(1) “Monetarily, money should be cheap and amply available”: Neutral. You might think that this factor should be rated as “bullish”, given how accommodative the Federal Reserve is currently. But Davis notes that banks are also significantly tightening their lending standards. Given the heavy debt load of both consumers and corporations suffer (see next criterion), banks are finding it “increasingly hard to find ‘credit-worthy’ borrowers”.
(2) “Economically, the debt structure should be deflated”. Bearish. This is the most negative of any of Davis’ seven dimensions, since the debt structure is by no means deflated. On the contrary, Davis calculates that the total credit-market debt load right now is nearly four times the size of gross domestic product, and that it takes more than $6 of new debt for our country to produce just $1 of GDP growth. That’s almost double the amount of debt required in the 1990s.
(3) “There should be a large pent-up demand for goods and services”. Bearish. Davis acknowledges that there has been improvement in this dimension from where things stood at the beginning of the bear market. But he is particularly worried by the ratio of total Personal Consumption Expenditure to Non-Residential Fixed Investment, which currently stands at a record high. At the secular bear market low in 1982, in contrast, this ratio was at a record low.
(4) “Fundamentally, stocks should be clearly cheap based upon time-tested, absolute valuation measures”. Neutral. Though the stock market “got undervalued at the March lows”, it never became “dirt cheap”.
(5) “Psychologically, investors should be deeply pessimistic, both in terms of the stock market and the economy.” Bullish. Davis says that past secular market lows were accompanied by extreme pessimism, and his indicators show a similar extreme existed earlier this year.
(6) “Technically, major investor groups should have below-average stock holdings and large cash reserves”. Neutral. While foreign investors have record-low stock holdings, according to Davis, household holdings – while low – are not nearly as low as they were at prior secular bear market lows. And institutional investors’ stock holdings “are only down to an average weighting historically”.
(7) “A fully oversold longer-term market condition in terms of normal trend growth and in terms of time”. Neutral. Davis believes that, though many of the excesses of the real-estate bubble have been worked off, some still exist. That’s particularly a problem, he says, given that the stock market bubble of the late 1990s never completely deflated either. “As we saw in Japan after 1990, a double bubble in stocks and real estate leaves it difficult to put ‘humpty dumpty’ together again.”
The research shows that only one of the seven criteria indicates that a secular bull is in place, whereas three are neutral and three are bearish. Although Davis believes the nascent rally has more upside potential, he concludes, like Richard Russell, that we are dealing with an extended rally (cyclical bull phase) within a secular bear market.
Looking at the next few weeks, I take a somewhat different perspective and am of the opinion that stock markets have run away from fundamental reality and that a pullback/consolidation looks likely. Taking a slightly longer-term view, I think we are in a (possibly lengthy) bottoming-out phase as far as slow-growth (OECD) countries are concerned, but already in new (potentially volatile) uptrends regarding high-growth emerging and commodities-related markets. Above all, I believe one should be careful of over-analyzing broad indices and at this stage of the cycle focus more strongly on selecting individual stocks with strong balance sheets and dividend-paying potential.
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