Nolte Report

Thu, Feb 16, 2012 - 4:09pm

Going back to the halcyon days of the Nixon administration, the duo of Woodward & Bernstein were admonished to follow the money. In the wonderful world of the internet, following the money might be a bit easier. The numbers are certainly much larger and their impact is just as important to investors as it was to the investigative reporters attempting to put all the puzzle pieces together.

Coming into office, Ben Bernanke had the unseemly moniker of “helicopter Ben” in reference to his comment regarding his “solution” to a Depression type of event in the US economy. Unfortunately for investors around the world, not only has Ben fired up the helicopter, but global central banks have expanded their balance sheets to incredible levels that investors would have never thought possible even in late 2008 as TARP began. According to Bianco Research, combined balance sheets of the Fed, ECB, Bank of Japan and Bank of England have more than tripled in size in just over three years from just over $4 trillion to nearly $14 trillion by yearend 2011. Consumers may be wondering where all that money has gone, as it hasn’t found its way into their back pockets. Economic growth, while better than the depths of the recession in early 2009, remain a long way from what historically has been a “normal” recovery. Thanks to the debt overhang that remains looming over the economy, this recovery is indeed very different than those of any since the Great Depression.

Many have outlined the differences between the economy and equity markets, as well as cautioned against focusing on the economy when investing in stocks. Here it is important to follow the money. There have been two announced rounds of quantitative easing in the US, operation twist and various monetary “injections” by central banks that have had an impact on the US equity markets since early 2009. There have been four separate rally periods since the bottom in 2009 that have roughly coincided with easing announcements. The only exception was the minor, early correction in June/July 2009 following the run up from the March 2009 lows. I have included it in the analysis below as the correction was above the “corrective” normal of 3-5%. What should not be surprising about the following analysis is that much like drugs, monetary “injections” have less and less impact with each subsequent dose.

The four periods are outlined in the table below:


There are a couple of things that are worth noting regarding the data when presented in this format. Using the drug analogy above, the initial hit of easing at the market bottom produced the greatest results in the shortest period of time, with each subsequent “hit” providing lower returns. Also, after the initial jump, the effects were not lasting as long with rally duration declining from 193 calendar days to the current rally of just over 100 days. It may be possible to see the current rally extend for another month or maybe two, but gains are likely to be small IF the overall target return is in the 25-30% range of the last two periods.

What did investors feel like around those dates above? This may also provide some insight into how much longer the markets may have to go higher as well as what the correction might look like in order to work off the euphoria. If we combined the sentiment readings from individual investors (as reported by American Association of Individual Investors) and Investment advisors (as reported by Investors Intelligence), a picture begins to emerge that indicates we are much closer to a correction than to significantly higher equity prices at this time. At the bottom of the market in March ’09, the combined “bullish” reading of these two sentiment indices was below 50, meaning the average “bullish” advisor or investor was less than 25%, with the remaining 75% somewhere between correction/bearish. At the modest peak in June ’09, bulls were hanging around 90. Each of the market corrections saw the bullish readings fall to 55-65 range and at the tops readings over 100. Today, there have been two weeks of 100+ readings within the last few weeks.

Thanks to help from the central banks around the world, money has been put into the financial system in an effort to ameliorate the effects of debt and possible defaults by banks around the world. It can be argued that the “helicopter money” has not made it down to the “grass root” level and is stuck in the trees above. The money seems to have found its way into the financial markets, boosting equity prices. That boost seems to be in the 20-30% range which has been achieved since the October 2011 lows, and combined with bullish sentiment may not leave much room for the markets to go significantly higher. A correction is likely in the cards in the weeks and certainly months ahead. The run higher is in need of a breather and given recent history, that time may be at hand.

About the Author

Managing Director
pnolte [at] dearpart [dot] com ()