Originally posted at Briefing.com.
Thinking about March 2009 could understandably induce some post-traumatic stress for a lot of people. That was a harrowing time to say the least. Still reeling from the Lehman Bros. bankruptcy and the greatest financial collapse since the Great Depression, the stock market was cascading lower and the US economy was imploding.
The S&P 500 traded below 700 in early March 2009 and real GDP growth was well on its way to contracting 5.4% in the first quarter after contracting 8.2% in the fourth quarter of 2008.
March 2009 was the worst of times in so many ways, but, boy, it was also the best of times for long-term investors.
No Guarantees
Our market-oriented thoughts were redirected to March 2009 recently after reading a CNBC article in which it was pointed out that the Bank of America Merrill Lynch Sell Side Indicator showed sentiment near its lowest levels since March 2009.
The indicator, it was said, measures how the biggest portfolio managers are positioned. It recently showed a stock weighting of 52.1% versus a traditional weighting closer to 60%. Reportedly, a buy signal is triggered when the weighting falls below 52.9%.
The inference is that the heightened degree of negativity toward stocks is a good contrarian indicator. History has proven that to be the case most of the time.
Read: Lakshman on US Slowdown, Shocks, and China
A move below the 52.9% threshold has preceded positive returns 95% of the time, with a median 12-month return of 24%, according to the CNBC article citing the work from Bank of America Merrill Lynch.
No one would quibble with such a return 12 months hence. The question is, can it happen this time?
Anything is possible, yet we feel obliged to make readers aware that there is no guarantee returns over the next 12 months will be so robust—if there is a positive return at all.
That's owed partly to the recognition that the economic and earnings growth trends continue to deteriorate. It's also owed to the understanding that this is February 2016 and things are much better than they were in March 2009.
Boxed In?
When we think back to early March 2009, we recall a period that was awash in negativity. The blame game for the collapse was in full bloom. The Federal Reserve (Fed), among others, was castigated for its role in things, but at the same time, it was still seen as a potential savior.
By early March 2009, the Fed had already taken the target range for the fed funds rate to the zero bound and had started down the road of quantitative easing (QE). It wasn't until the March 18, 2009, policy directive, though, that the market truly came to appreciate the Fed's halo effect.
It was then that the Fed cranked up its commitment to quantitative easing. As everyone knows by now, the Fed didn't stop there. QE2, Operation Twist, and QE3 eventually came to pass, yet it was the QE announcement in March 2009 where the Fed got the most bang for its QE sentiment buck.
It was something that was new and fresh and signaled some "oustside-the-box" thinking that many appreciated and thought at the time would be the ticket to escape velocity for the US economy. Seven years later, many now think the "outside-the-box" approach simply boxed in the US economy, which has yet to reach escape velocity even though QE helped launch one of the best bull markets in history.
No one can argue legitimately that the Fed's monetary policy didn't help the US economy come back from the financial crisis abyss. With long-term rates being suppressed and the Fed put in place, spending picked up again as layoffs subsided, job growth resumed, corporate profits started to grow again, and household wealth increased. We can see the path of economic recuperation in the charts of auto and home sales.
What we can also surmise from the charts above is that the Fed's monetary policy has most likely pulled forward demand. That is, the persistence of low rates has encouraged consumers to make big purchases sooner than they might have otherwise out of some fear that their ability to do so in the future would be impeded by higher interest rates.t
That won't kill future growth altogether, yet it will likely act as a retardant on future growth, particularly if income growth is lacking.
Check out: Krinsky on Stock Market: Primary Trend Has Shifted to the Downside
The US economy is in much better shape today than it was in March 2009. That point is indisputable. It still isn't in great shape, however, for a number of reasons, one of which is that time and data have shown that QE and zero interest rates haven't been the economic savior many thought they would be in March 2009.
This is February 2016 and faith in the Fed is not nearly as strong as it was when the world was awash in negativity.
Cheaper, but Not Cheap
The biggest, and most important, contrast for investors between now and the dark days of March 2009 is valuation.
With the recent sell-off in the market, we're hearing a number of pundits suggest the market is cheap now. What can truthfully be said is that the market is cheaper now, but it isn't cheap when viewed through the lens of the Shiller P/E ratio.
The Shiller P/E ratio, which is based on average inflation-adjusted earnings from the previous ten years, stood at 13.3 on a monthly basis in March 2009. That was the lowest it had been since March 1986 and it was 32% below the 50-year average of 19.7.
When 2016 began, the Shiller P/E ratio was 26.0. It has since come down to 24.4, which is 24% above the 50-year average and only a 10% discount to the 20-year average, which encompasses both the dot-com bubble and the Great Recession.
There may be pockets of the market that have gotten cheap with the recent sell-off, yet it's a valuation stretch to call the market cheap.
The salient point of it all is that future returns will be lower when starting from a point of high valuation.
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In March 2009, one could see the light of strong profit growth at the end of the dark tunnel. Profit margins were severely depressed.
That is not the case in February 2016. Profit margins are close to record highs today thanks to interest rates that have remained low, extensive cost-cutting efforts, and limited, if any, wage growth.
It's tough to pay a high earnings multiple to own the market today knowing there doesn't appear to be a whole lot of room for future profit margin expansion, particularly if interest rates, labor costs, and commodity prices start moving higher, which they haven't yet done to any great and sustainable degree.
What It All Means
Sentiment can be a very worthwhile, and rewarding, contrarian indicator. There are times though when bearish sentiment is rooted in strong fundamental factors as opposed to just emotional perspectives.
In March 2009 sentiment was extremely negative. Emotions were running very high, valuations were running very low, and the Fed was seen as providing a monetary policy cure. It was a great combination for producing positive future returns.
Today, it's fair to say that the sense of negativity is nothing like it was in March 2009, that the market's valuation is high, and that the Fed's approach to conducting monetary policy is no longer the elixir for the stock market it once was -- and that's whether you take the view the Fed is now trying to tighten policy or the view that its extraordinary policy was long on promise but ultimately short on economic returns.
In March 2009 things were really bad. They were so bad that they were good for long-term investors. Valuation was cheap, profit margins were depressed, and there was a long runway of upside potential.
Things are a lot better today. How do we know? Valuation is stretched, profit margins are near record highs, and stock market gains have amassed over the last seven years to a point that there now appears to be more downside risk than upside potential.
In short, this is not March 2009 and that may just be a bad thing for future return prospects.
