At what rate will the end come?

Alan Bush

Some analysts say the bull market in the S&P 500 futures that began in March of 2009 is getting tired, as it now is well into its sixth year. It is true that this bull market has exceeded the average bull market in its duration, not to mention its scope of advance. On the surface it seems only logical that it is about time for this market to tip, as many analysts have become bearish and are predicting a major top.  

There are a variety of reasons why the bears are calling for this historic advance to end. Some of the bearish logic is better than others. For example, many of the bears say it is high time the Federal Open Market Committee (FOMC) increases its Fed funds target, in light of the fact that it has remained at 0% to 0.25% since December 2008. Bolstering the bearish argument is the consensus view that the Fed will increase its fed funds rate at either this year, possibly as early as the September FOMC meeting. I am fully aware that the virtually zero interest rate has been in place for a long time. It has been that low because it needs to be that low. But why should the Fed raise interest rates now, especially since the economic recovery has been so uneven? That long time at zero to 25 basis points is likely to get even longer.

Some of the bears say this advance in stock index futures has to end soon simply because it has persisted for “too long” and is “looking old.” One analyst said, “After a very long advance and after the new record-highs in S&P 500 futures, at a certain point there is nowhere to go but down.” Our response is, of course it is true that a bull market can’t go on forever, but why should it stop now? 

In addition, there are other negatives, one of which is the slower growth in corporate earnings. Recent 12-year highs in the U.S. Dollar Index in March have meaningfully dented the earnings of multinational U.S. companies in the first quarter. How much higher can the U.S. dollar go without being even more of a drag on the U.S. economy? My answer to this question is not much. In fact, the U.S. dollar has already topped, which will alleviate the pressure on the earnings of U.S. multinational corporations.

In spite of all of these reasons to be bearish, none of them separately or combined appears to be powerful enough to reverse this bull market. There is one dominant influence that has overpowered all others since this bull market began and will continue to dominate for at least the balance of 2015. That is the historically low U.S. and global interest rate structures that are likely to stay low for much longer than most analysts currently predict. While the consensus view is that the Fed will increase rates sometime in the second half of this year, my minority opinion remains that the Fed will increase interest rates later rather than sooner and maybe not until 2016. Among my reasons for a further delayed tightening of monetary policy are very low real wages, the extreme weakness in the velocity of money and the recent U.S. dollar strength. A delayed rate increase from the Fed will continue to be the fuel that takes S&P 500 futures higher this year. 

But, I have to face the fact that eventually the Fed will tighten monetary policy, whether it’s this year, or in 2016, and at that time many analysts will be calling for a top in stock index futures. They will say an interest rate increase from the Fed will be the nail in the coffin that ends the bull market. But I have heard this doom and gloom before. In fact, at the end of each of the three rounds of quantitative easing and the “Operation Twist” program, there was a deafening roar on the part of the bears calling for a new bear market to ensue. And what happened each time just before, or soon after the conclusion of these Fed initiatives to stimulate the economy? In every instance S&P 500 futures temporarily sold off, recovered and then made new highs. 

Since the Fed will remain historically accommodative even after its first interest rate increase in many years, regardless of when it occurs, any setback in prices will be short lived and will not be the beginning of any new bear market. Although there is a growing chorus of analysts saying the days are numbered for this “old” bull market, my analysis suggests this “old” bull market has plenty of life left. Remember, it will not be the first increase in the Fed funds rate that halts a bull market for S&P 500 futures; it will be the last one.

Note: The opinions in this article are those of Alan Bush and are not to be construed as the opinions of ADM Investor Services, Inc., or Archer Daniels Midland Co.

Matt Weller

There are no two ways about it: Betting against the S&P 500 uptrend has been a fool’s errand during the last few years. It’s now been nearly four years since the S&P 500 last saw a 10% pullback on a closing basis—the third-longest streak in the last half century and well beyond the historical average of one such correction per year. Some traders may argue that this means that a drop is long overdue, but that thought process is already littered with the bodies of other too-early bears. So why am I willing to stand in the way of the runaway bullish freight train?

For one, there are some alarming fundamental developments that we haven’t seen since the bull market kicked off in 2009, and in some cases, since the start of recorded history. Even the most ardent of bulls will admit that stocks are fully valued, if not outright expensive relative to history. The S&P 500’s trailing P/E ratio currently sits well above its long-run average at about 21, with longer-term valuation measures like the 10-year cyclically-adjusted P/E ratio coming in at 27, nearly 60% above its historical mean. While stocks could easily become even more richly valued, it’s difficult for bulls to make a case that they’re buying at an attractive level relative to history.

Meanwhile, S&P 500 companies saw an outright contraction in revenues in Q1 and just squeaked out a marginal increase in earnings through aggressive cost cutting. Such measures are not sustainable, especially with labor market tightening. The April JOLTS jobs openings report showed a record-high 5.4 million job openings, indicating that employers will have to start hiking wages aggressively to attract qualified candidates.

Of course, bulls argue that the lackluster Q1 earnings results were driven by temporary factors, including the negative impact of falling oil prices on energy companies and the sharp rise in the value of the U.S. dollar, which hurt multinational companies. Undoubtedly, the energy sector’s earnings will recover now that oil prices have stabilized, but the true wildcard is the greenback. As of June 10, both the Fed and futures markets expect an interest rate hike at some point this year. This marks a sharp monetary policy divergence between the United States and the rest of the developed world and should continue to attract funds to the dollar in the coming months. The impact of a strong dollar on corporate earnings is often over-exaggerated, but the potential for continued dollar strength could still provide a headwind for large company earnings. 

In addition, traders are borrowing aggressively to buy stocks on margin, a historical warning sign for the S&P 500. NYSE margin debt recently hit an all-time high above the $500 billion threshold, signaling potentially excessive speculative froth in the market. 

Many of these fundamental concerns could be shrugged off if we also weren’t seeing technical signs that the market was losing steam. As of June 10, the S&P 500 is up only marginally on the year, despite being in the historically-bullish third year of a presidential cycle. More to the point, the index has been unable to maintain a breakout to all-time highs for more than a few weeks since the start of the year. The sputtering uptrend is particularly evident in the weekly chart, where both the MACD and RSI indicators are showing prolonged bearish divergences, confirming the waning momentum.

Market internals show an additional reason for concern. The number of stocks participating in each subsequent rally is falling. A key way to measure market breadth is to look at the percentage of stocks trading above key moving averages, and there have been fewer S&P 500 component stocks trading above their 50- and 200-day moving averages on each index peak in 2015. This narrowing breadth shows that traders are piling into a few crowded market leaders. In other words, the stock market is still rising, but the “market of stocks” is not rising in sync.

The panoply of bearish developments is enough to put any reader on edge, but price will always rule.Traders should keep a close eye on the 12-month moving average to confirm a medium-term shift in favor of the sellers. Since the 2009 trough, a monthly close below this key support level has preceded both of the 15% corrections we’ve seen and if seen again, could be the proverbial “straw the breaks the bull’s back.”