What Doesn't Kill Bull Market in Stocks May Make It Strongerby
Equity funds see near-record outflows into 7th anniversary
No faith in bank shares as valuation discount persists
“How low can stocks go,” the Wall Street Journal wondered on March 9, 2009, as the financial crisis was wiping away trillions of dollars from American equities, the deepest rout since the Great Depression.
That day, of course, marked the bottom. The bull market that celebrates its seventh anniversary today has restored $14 trillion to stock values, pushing up the Standard & Poor’s 500 Index by almost 200 percent.
Now, investors are awash in angst, showing little faith the run can continue. They worry about contracting corporate earnings, slowing Chinese growth and uncertainty over interest rates. And they’re walking the talk by pulling cash from stocks at almost the fastest rate on record. It’s not unwarranted -- the S&P 500 has gained just 0.5 percent in the last 18 months.
Yet if history is any guide, that very cynicism provides a compelling case for the run to persist, at least by traditional market analysis. Bull markets usually die amid excessive optimism, and that’s nowhere to be found.
“This pervasive pessimism, skepticism and unwillingness to invest in equities anywhere near the degree we’ve seen in past bull markets has been a very unique characteristic,” Liz Ann Sonders, chief investment strategist at Charles Schwab & Co., said on Bloomberg Radio. That contrarian sentiment constitutes “the wall of worry that stocks like to climb,” she said.
Consider all that money flowing out of equities. Investors took out almost $140 billion from equity mutual and exchange-traded funds in the last 12 months, more than double the peak outflows experienced over any comparable periods during the global financial crisis.
Yet when people withdraw money, stocks inversely tend to rise later, according to data since 1984. In the 12 instances when funds experienced monthly outflows that were at least 2 standard deviations from the historic mean, the S&P 500 rose an average 7.1 percent six months later, compared with a normal return of 3.9 percent, data compiled by Bloomberg and Investment Company Institute show.
Even the horrendous start to 2016 showed how skittishness may eventually work in favor of bulls. The first six weeks delivered the worst-ever beginning of a year for U.S. equities. They also saw a surge in the number of days with moves of 2 percent in either direction.
But once things start to turn around, bears will be forced to buy. From Feb. 11 through Monday, a Goldman Sachs Group Inc. index of the most-shorted companies outperformed the S&P 500 by almost 16 percentage points, the most in data going back to 2008.
Distrust also creates bargains and emboldens future buyers.
That’s the case with financial shares, which led the latest rebound from the February low. Banks and insurers, the biggest profit generator in the S&P 500 with $228 billion in income last year, still get little respect from investors after being blamed for the market turmoil during the downturn. At 13.6 times earnings, the group was handed the lowest valuations among 10 industries and traded at a 24 percent discount to the S&P 500.
As the market started to recover, financial companies rallied. So did some of the most-hated stocks such as energy and materials producers that had been borrowed and sold in a practice known as a short sale. The forced buying from bears therefore added additional fuel to the S&P 500’s gain from a 22-month low.
What happens next? Wall Street strategists see the bull market lasting at least through December, with the S&P 500 rising to 2,158, or an 9 percent increase from Tuesday’s close, according to the average of 21 estimates compiled by Bloomberg. If the run lasts until the end of April, this bull will become the second oldest on record. Coincidentally or not, the last two ended near the eighth year of an election cycle.
The benchmark index rose 0.5 percent at 4 p.m. in New York.
Tom Mangan, senior vice president of James Investment Research in Xenia, Ohio, which oversees about $6.5 billion, isn’t ready to throw in the towel.
“There are too many bears versus bulls and there is too much cash on the sidelines," he said. “That means the market can do better.”