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David Joy Will stocks continue their climb?

The S&P 500 closed above 1500 on Friday for the first time in over five years, but will the rally last?

 

The S&P 500 continued its ascent last week, closing above 1500 on Friday for the first time since December 10, 2007, ending the week at 1503. It has taken the index more than five years to recapture this ground, and leaves it just four percent from its all-time high of 1565, reached on Oct. 9, 2007, two months before the Great Recession began. From its low of 677 on March 9, 2009 the index has risen 122 percent.

Just this year alone, the S&P 500 has already added more than five percent. Every sector is higher, although for telecom, it is barely so. And, at any other time the 3.8 percent gain in utilities would be greeted warmly, but looks downright paltry when compared to the more than seven percent gains in energy, consumer discretionary, and health care sectors. And don't be fooled by the meager 1.3 percent gain in technology. It largest constituent, representing 21 percent of the sector, is Apple, which is down 17 percent so far this year. Its decline alone has knocked almost four percent off the overall sector's return.

It is impossible to say whether stocks will hold onto these gains in the near-term. Market technicians point out that bullish sentiment is running high, and that a high percentage of individual stocks are at short-term highs, both suggesting some market exhaustion ahead. In a larger context, they also point out that it was just beyond the 1500 level that the S&P 500 peaked in 2000, as well as in 2007, only to be followed by punishing bear markets.

But even if stocks are due for some consolidation, today's environment seems very different from those two prior episodes. In 2000, a bubble existed in technology stocks. According to Bloomberg, the NASDAQ Composite carried a price/earnings multiple of 175x when the index peaked in the first quarter of 2000, compared to a long-term median of 32, and 24 currently. It went on to lose 3/4 of its value in the next two years. In 2007, there was a bubble in leverage. Everywhere, balance sheets were overextended, and asset prices were bid to unsustainable levels as a result. In the aftermath, investment banks disappeared, home values declined by 1/3, and stocks fell by 57 percent.

Today's excesses reside in the public sector, and perhaps in the bond market as a consequence. Private sector finances have generally been stabilized or repaired. But this has come at the expense of rising public debt and a bloated Fed balance sheet. These distortions carry longer-term risks, including possible inflation, higher interest rates, loss of competitiveness, and failed promises.

As a nation, we still have time to address these fiscal imbalances. Perhaps more will be accomplished in the months ahead. Let's hope. But for bond investors, maybe the immediate concern is how much upward pressure on market rates, and downward pressure on bond prices, will an improving economy exert?

Consider that since its post-election low on Nov. 15, the S&P 500 is 11 percent higher. On the same date, the yield on the ten-year Treasury note was 1.59 percent. At the close last Friday, it was 1.95 percent. Inflation is not higher since November, Fed policy is not less accommodative, and Congress has made an initial attempt, albeit modest, at closing the deficit. What have changed are investor perceptions of improving economic conditions and receding financial stress. And, along with that, comes the prospect of rising demand for credit, and a rotation out of bond investments into stocks. On Friday alone, the ten-year note yield spiked ten basis points and declined in price by almost a full percent. Since November 15, its price is down 3.2 percent. Under such circumstances, the note's 1.625 percent coupon provides little cushion. On Friday, lower quality corporate bonds rallied, further evidence of rising risk appetites.

According to the Investment Company Institute, net money flows into long-term equity funds have so far turned positive in January after outflows in ten straight months through December, and in 19 of the past 20.

It is too soon to anoint this the start of the so-called great rotation. It has only been going on for a couple of weeks, never mind months. And notably, bond fund flows remain positive themselves. But it bears watching.

The question of the just how influential economic data is on stock prices and bond yields will be tested in the week ahead. There are a number of significant reports on the economic calendar, including a Fed meeting, January employment, ISM manufacturing, and fourth quarter GDP. How markets react to any surprises will provide the answer.

Important Disclosures:

The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.

The NASDAQ composite index measures all NASDAQ domestic and international based common type stocks listed on the Nasdaq Stock Market.

It is not possible to invest directly in an index.

Investment products are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution and involve investment risks including possible loss of principal and fluctuation in value.

Brokerage, investment and financial advisory services are made available through Ameriprise Financial Services, Inc. Member FINRA and SIPC.

 

www.ici.org, January 2013

 

This post is contributed by a community member. The views expressed in this blog are those of the author and do not necessarily reflect those of Patch Media Corporation. Everyone is welcome to submit a post to Patch. If you'd like to post a blog, go here to get started.

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