Is market history repeating itself?

Rick_PendergraftIn last week’s article, I talked about interest rates and how I was looking for them to rise in the coming months. Part of the reason for that insight was the outlook for the U.S. economy and the economic reports that were due out last week. The reports were even more impressive than I thought they would be, and they beat the analysts’ expectations.

The advanced look at the second quarter GDP was expected to show growth of 3.2%, and yet it came in showing a growth rate of 4.0%. Consumer Confidence was expected to come in at 85.6, but came in at 90.9. Non-farm payrolls didn’t beat the expected level, but they were still pretty impressive. And at least 200,000 jobs were added for the sixth-straight month!

So if all of this good news came out in one week, why did the S&P (a representation of the overall market) lose 2.69% on the week? Why did the index suffer its worst week since May 2012?

I hinted at the issue last week, and it came to fruition to a degree. Investors are worried that the economy is improving enough that the Fed will raise rates sooner rather than later. Most experts are predicting that the first possible move by the Fed won’t come until the second half of 2015 at the earliest. However, with the GDP growing at its current rate and the employment picture improving drastically, the experts are reconsidering their predictions.

With the new expectations, investors are concerned that the Fed shifting from an accommodative policy to a tight monetary policy will cause the economy to stall, and thus, stall corporate profits. Personally I am more concerned with the overbought levels, the pattern in the S&P, and the way this rally has been manufactured.

Let’s start with the overbought levels on the S&P 500. Looking at the monthly chart, the 12-month RSI and the monthly slow stochastic readings are both in prolonged overbought states. In fact, the indicators have been in overbought territory for the longest period since the late 90s. Yes, the extended rally that occurred right before the bear market of the early 2000s was the last time we saw the S&P remain in overbought territory for such an extended period. And if that isn’t enough to scare you, consider the fact that from 1995 to 2000, the index tripled in value before the bear market caused it to lose half of its value in two and a half years. Since the low of 666.79 in March 2009, the S&P has gained just under 200% (198.7%) from the low to the high so far.

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Now let’s look at where the unemployment rate, GDP, and interest rates were during that last prolonged rally. The unemployment rate had fallen from around 7.8% in 1992 to just under 4% in early 2000. The present unemployment rate has fallen to 6.2% from a peak of 10% in 2009. The annualized GDP growth rate was above 4% from mid-1996 until the first quarter of 2001. The most recent reading for the GDP growth rate was celebrated for coming in at 4.0% for the first time since 2004. Yet the annualized rate is still only 2.4%.

Throughout most of the current rally, the GDP growth rate has been between 1.5% and 3%. Turning our attention to interest rates, during the bull market of the second half of the 1990s, the Fed Funds rate ranged from 4.75% to 6.5%. During the current rally, the Fed Funds rate has been held constant at 0.25% for the entire five years.

The point is that the current rally has been similar to the rally in the late 90s in that the S&P has nearly tripled in price over the course of five years. The oscillators are starting to look similar to what they looked like during the previous bull market as well.

However, the current economy looks nothing like the economy of the late 90s. The unemployment rate has fallen nicely over the last five years, but it is still higher than the highest level of the late 90s. The annualized GDP growth rate was above 4% for four and a half years during the previous rally. During the current rally, the annualized rate has yet to break the 4% barrier.

The current rally has been manufactured primarily by an accommodative Fed, and the performance of the S&P is eerily similar. However, what will happen when the Fed stops being so accommodative? Will companies be able to show the same growth rates? Remember, it was the earnings disappointments that started the bear market that lasted from late 2000 until early 2003.

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