4 Big Lies About the Bull Market - Weekend Wisdom

It’s not much fun being a bear in a raging bull market. Every time it looks like the big correction is coming because of the latest worry, the market turns right around and makes new highs.

Earlier this week, I outlined a few of the strong fundamental drivers for continued earnings growth and higher stock prices. Today I want to focus on the bearish propaganda that can get in the way of seeing those fundamentals.

Here are 4 big lies to see through…

1) The Bull is a Bubble

When pundits and forecasters throw around historical facts about market valuation, things can get confusing quickly. There’s the “P/E 10″ which adjusts to cycles by using a ten-year average of earnings.

And there’s the “Warren Buffett indicator” which looks at the stock market’s total capitalization as a percentage of GDP. Both of these yardsticks say the market is currently overvalued with the P/E 10 at 25 times for the S&P 500 and the market cap/GDP ratio at about 125%.

But are these measures meaningful in an economy producing 3%+ GDP, steady jobs growth, and record corporate profits? I think simple is best here. How about just comparing the trailing P/E and the forward P/E to previous bull market tops?

The 12-month trailing P/E is around 18 times. That sounds like it’s getting expensive if we use a simple scale of 15 to 20 for “cheap to dear”. But six previous tops (not including 2008 when earnings went negative) averaged 30 times.

The 12-month forward P/E is 15.9, based on S&P 2030 and the consensus 12-month EPS estimate of $127.50. When investors are paying only 16X for record earnings growth in an economy that is just starting to pick up momentum, I say it’s not nearly a bubble yet.

Talk to me about bubbles when either one of two things happens: the trailing P/E hits 20X or earnings estimates start coming down because of a potential recession.

2) It’s All Fueled By QE

This is where the bears get really excited because they believe they have someone (the Fed) to blame for “manipulated” markets. But let me walk you through their faulty logic so you can see what’s really going on here.

More . . .

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Yes, the Fed creates new money to buy bonds. But where did that money go? It went into the bond market where primary dealers in government securities had a couple of options on how to spend it. Mostly, the money either found its way into their banking excess reserves or was used to buy new bonds.

Every bond dealer who sells a Treasury or MBS security to the Fed has an investment obligation and an entry on their balance sheet. They don’t have “free money.”

Could some of that money find its way into the economy or the stock market? Sure. But not enough to make an effective difference for what’s really driving this bull.

While extremely low interest rates are somewhat responsible for high margin debt levels, what we know right now is that QE bond-buying didn’t fuel the bull market.

3) We’re Still in a Secular Bear

There’s a curious notion out there that says the stock market follows regular and precise cycles. And in the past century or so, big bear markets have lasted 17 years. This is from a massive sample size of occurrences you can count on one hand I believe.

But a funny thing happened on the way to the market’s next expected plunge in year 13. It burst through the old highs from 2000 and 2007 at S&P 1575 and just kept right on going.

Apparently what is lost on the bears, and their cycles, is that the economy and earnings — the underlying drivers of the market — don’t care about rhyming with every historical fact.

Something else that scares lots of folks is that “the market is up 200%!”

Yes, from the 2009 bear market lows, the S&P index is up 200%. But on a fundamental basis, the stock market should never have gone below S&P 1000. In my research, I like the nearly 20% correction we had in 2011 and that test of S&P 1100 as my baseline for the bull market.

And we’re up less than 100% from there. 2011 was also when we learned that this economy could handle just about anything, from European meltdowns to Washington brinksmanship. More fear and market loathing in 2012 only served to solidify the bull case for stocks.

4) Economic Cycle on Borrowed Time

Here’s another one where prognosticators draw from history to propose that this bullish environment has to end soon. Since 1854, there have been 34 economic expansions, with the average lasting 39 months and the median at 30 months.

This current expansion has been in progress for nearly 65 months, making it the sixth longest. While it’s true that economic expansions and their equity bull markets don’t last forever, I believe this pair is unique and will keep running smoothly as it seems to avoid the traditional “boom-bust” extremes with steady “not-too-hot-nor-too-cold” growth.

What’s more, the last 3 economic expansions were longer than all but 2 of the prior 34. My point is that we can’t compare this economy and its cycles to anything that happened before WWII, or anything before the microchip I dare say.

Besides the economic megatrends of technological innovation and Emerging Markets, where over 2 billion people are clamoring for the lifestyles of the West, there is the wealth underneath our GDP. According to Ronald Reagan’s economic architect Dr. John Rutledge, the capital base of the US sat at $234 trillion in mid-2013.

Now that the QE training wheels have been taken off, two other competitive forces will be unleashed in this $234 trillion economy soon: banks lending their massive reserves and corporations putting cash to work in capital investment instead of merely buying back stock.

Let’s see if we can make this the 5th longest expansion.

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Good Investing,

Kevin Cook

Kevin, a Senior Stock Strategist at Zacks, is a recognized authority in global markets and renowned for predicting market swings. A former market-maker in the $4-trillion-dollar-a-day world of interbank trade, he developed the ability to track the movement of money, and trained his reflexes to take advantage of it. Today he directs the Zacks Market Timer, providing commentary and recommendations.

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