Is this the Top of the Rally?
We have now reached a point in this recovery from the recession of 2007/9 where companies are enjoying very favourable trading conditions.
GDP growth has resumed and, whilst it may not keep going at the pace seen in the last quarter of 2009 (which was greatly helped by inventories being rebuilt), GDP looks set to continue growing slowly. So the cake from which each business takes its slice of turnover is now growing again.
There is still plenty of spare capacity which can be used up to meet new orders before much needs to be spent on building (or buying) additional capacity. We are seeing capex well below depreciation, which boosts companies’ cashflow.
There is plenty of slack in the jobs market (9.7% US unemployment rate) and employers will first look to increase workers’ weekly hours (which fell during the recession) before considering hiring new staff. We are also seeing subdued pay rises which helps profits.
After witnessing the banks’ collectively reduce credit lines and tighten their criteria for fresh lending, the companies’ collective response has been to pay down as much debt as possible through cashflow and/or rights issues. Less interest paid also raises profits.
Whilst governments around the world may kid themselves that they are all going to export their way out of trouble, businesses are well aware that not every country in the world can rely on exports at the same time (someone has to run a trade deficit to buy all those exports).
Within their own countries, those businesses which survived the recession are benefiting from the demise of their competitors. The survivors are enjoying a bigger share of a smaller cake and this helps to explain why sales taxes (e.g.VAT) are still down but corporate profits are nevertheless growing.
Given that central banks are going to keep interest rates at record lows until employment picks up markedly (whilst inflation remains absent), businesses are able to enjoy this prolonged sweet spot where they fill additional orders by using up their spare capacity and giving existing workers a few extra hours to create the additional output.
However this is all well and good but all of the above is already known and the rally since March 2009 has discounted these facts into current stockmarket prices. Some job creation has started in the States, which is a further sign confirming economic recovery. Eventually this will lead to a bear market in Treasury bonds in textbook fashion, and rising long-term rates will put downward pressure on the stockmarkets. Now that the S&P has almost reached its 200-week moving average (having also retraced 61.8% of the entire 2007-09 bear market), it is time for the stockmarket to do a bit of sustained backing-and-filling. The Dow has already reached its 200-week moving average (11,133) and these levels are not far off where markets closed on 12 Sep 2008, the eve of Lehman’s bankruptcy (1251/11421 for the S&P/Dow). Remember that the bigger picture (see Anatomy of a Secular Bear Market) calls for a rally off the bottom and then a deep pullback which creates a trading range. Since March 2009 we have been rallying off the bottom in search of the top of the trading range. The 1224/11133 area on the S&P/Dow may well turn out to be the top of the new trading range. Sensible long-term investors should look to top-slice their holdings and take some chips off the table, particularly in high-beta sectors such as banks, insurance & miners.
Tags: 200 week, anatomy, banks, bear market, business, companies, debt, dow, gdp growth, insurance, miners, moving average, rally, S and P, secular, trading range