The S&P’s surge past 1360 is ripe with meaning.
We’re there already — at 1360 for the S&P. That was the average year-end 2012 number forecast by the 10 Wall Street market strategists we polled for Barron’s annual outlook cover feature (« Buckle Up! » Dec. 19, 2011). The Standard & Poor’s 500 index closed Friday at 1361.
This says equally as much about the collective sobriety of the sell-side establishment after a tortured 2011 market path and the impressive vigor of the equity market in 2012.
The 8.2% gain this year has been generated almost exactly as the most bullish handicappers would have drawn it up, with investors overlooking stalling corporate-profit growth; favoring the higher-growth and cyclical sectors; smiling on firm (if mild-weather-aided) domestic economic data; rotation among sectors and stocks as news dictates rather than trading the entire market as a single instrument; and, with all this, investors’ opting to pay a higher aggregate multiple for equities.
This performance, as noted here last week, has closely resembled, and now exceeded, the happy start to 2011, which came months into the Federal Reserve’s QE2 bond-purchase campaign. Indeed, coming into the year, there was the risk of overthinking the market, given the backdrop of hypereasy (not to say desperate) central bankers.
As HSBC’s global strategists point out, the latest leg of this rally commenced with the European Central Bank’s long-term refinancing operation (LTRO) of buying government debt and back-stopping banks for three years.
As we suggested in Streetwise (« Reason to Rally? » Dec. 12, 2011), « These plans are being dismissed as pathetic half-measures that point up the lack of a ‘grand bargain,’ which presumably would be a massive money-printing program by the European Central Bank, managed government defaults, enforceable austerity plans or some combination of them. Yet they could be just what the market needs to head higher. »
More broadly, the ECB’s balance sheet, last reported at $3.6 trillion, is piled atop the $2.9 trillion in assets at the Fed and another $500 billion at the Bank of England. That total of $7.6 trillion in conjured money loosed upon the financial system is up more than 350% from before the financial crisis, and amounts to about 30% of the total equity-market capitalization of the U.S., European and U.K. stock markets.
There isn’t anything like a one-to-one relationship between central-bank balance-sheet expansion and higher stock prices. But it penalizes risk aversion, becalms credit markets, and creates potential monetary energy that animates the entire risk spectrum, from corporate bonds to stocks to commodities.
The notion that central banks have investors’ backs, even given the long-term hazards of so much cheap money washing over the globe, has joined with the jaunty stock-market action to lift investor sentiment rather predictably.
Consider statements such as this one by a senior trader, as quoted Friday by the Wall Street Journal: « With Treasury rates where they are, there’s no real alternative to U.S. equities. »
Of course, no investor inhabits an impermeable bubble in which those are the two binary options, as last week’s record inflows into investment-grade bond funds show. If we’re to see a wholesale reallocation toward stocks, it would have a long way to go, but this is far from assured. This « Where else are you going to go? » rationale tends not to survive a fundamental or liquidity test.
The general comfort with U.S. economic momentum, justified so far, also opens the crowd up for short-term disappointment. The Citigroup Economic Surprise Index, a gauge of macro data versus expectations, peaked at toppy levels last month and has rolled over a bit. The rise in crude oil to a nine-month high is now being taken as affirmation of a better economy, but at some price would become a drag.
HSBC points out that these central-bank-aided rallies tend to pay diminishing returns upon repetition, and markets jeer their expiration. The ECB is scheduled for one more securities-purchasing round Feb. 29, and has signaled no intention of doing another.
This, along with signs of flagging market momentum beneath the surface and the aforementioned contented sentiment backdrop, leaves stocks vulnerable to some kind of near-term setback. However, it would likely not be fatal to the general uptrend, barring something nasty from the blue.
Ultimately, by the way, the most positive, and perhaps surprising, thing for investors would be if the environment kept improving to the point where the central banks and their various exertions were no longer the story.