It’s reassuring, in a way, that for all its fickle moods and unpredictable reactions, the stock market can always be counted on for one thing: confounding the expectations of the crowd.
For example, almost no one spent December hopscotching from conference room to TV studio predicting we were about to head back to 1980s Wall Street, with consumer and branded-goods stocks riding high, junk-bond issuance hitting records and corporate raiders flashing their swords. Yet that’s about what we’ve seen.
Even among those who correctly expected stocks to rise, the majority missed how and at what pace they've headed that way.
The standard Wall Street line coming into the year, delivered during the policy bar fight that spilled into the street after the election, went something like this: “Stocks should do better than bonds in 2013, with potential for the typical 10% annual gain that professional market handicappers cluster around. But the first half will be weaker and more volatile than the second half, given higher taxes kicking in and partisan gridlock blocking progress on the deficit. Only when politicians reach some ‘grand bargain’ on long-term structural fiscal issues will CEOs and investors gain confidence enough to spend, hire and take market risk.”
Indexes popping higher
As it’s happened, of course, the core stock indexes popped higher on day one of the year and have mostly kept rolling upward ever since. The Standard & Poor’s 500 index is up 11% so far this year, more than the average annual gain through documented history.
As suggested in the Daily Ticker video that accompanied this year-ahead market outlook, the challenges often seem more present and vexing than do the prospect of upside surprises – but that in itself was reason to think the market had already moved beyond the headline issues.
As tabulated by Bank of America Merrill Lynch strategist Savita Subramanian, brokerage strategists as a group were recommending clients devote less than 50% of their portfolios to equities – an extreme low rarely seen in three decades and a sign of the sort of ingrained bearishness that usually foretells above-average market returns to come. This gauge has only slightly increased since.
According to a Barron’s survey of investment-firm strategists in December, the pros were looking for globally exposed tech and industrial stocks to be the best performing groups, while consumer staples, telecom and utility shares appeared to them expensive and unattractive.
In the event, the upside leadership has come from the disdained healthcare, staples, utilities and telecom areas – dubbed “Grandma stocks” here – along with consumer-discretionary shares.
The '80s vibe
This has generated the noted back-to-the-‘80s vibe on Wall Street. The recent “defensive” nature of the market pacesetters has bothered many investors used to cyclical, small-cap and emerging-market stocks pacing a healthy rally over the past couple of cycles.
Chris Verrone, a technical market analyst at research firm Strategas Group, last week sent around intriguing charts of all 30 Dow Jones Industrial Average components in the years surrounding the early-‘80s bull market. It was indeed consumer-staples and healthcare names that were first to vault to new highs, with commodity-related and heavy-industrial names trailing behind.
The macroeconomic and valuation backdrop today does not compare favorably in most ways with those days, so we are almost certainly not in for the kind of enormous long-term forward stock returns that lay ahead of investors 40 years ago.
Yet the character and some drivers of the market now are similar. Beginning around 1984, the stock market did vastly better than the U.S. economy’s growth might have implied, as is now the case. The market was emerging from years of small-stock outperformance and rediscovering blue chips; ditto today. Stocks both in the ‘80s and today are being bought because they’re perceived to be where investor money is treated well, as cash is exchanged for portions of real companies with enduring cash-flow and dividend potential.
The Federal Reserve today is pumping unprecedented amounts of liquidity into markets, of course, which is a clear distinction from the early ‘80s. Yet then the Fed was loosening money quickly to help unleash torrents of pent-up demand for credit.
The price of junk
Junk debt is just about the most voraciously bought, and richly valued, asset in broad circulation today. Their 5% to 6% yields hardly resemble the high-teens cost of the debt that helped spur the ‘80s corporate-shakeup trend. Yet in both cases they are enabling broad-scale financial engineering – the synthesized, adrenaline-stoking music that accompanies energized capital markets. Debt costs are so low today that companies are busy buying themselves through stock repurchases. Activist hedge-fund managers are working increasingly to extract value from inefficiently run businesses, such as Occidental Petroleum Inc. (OXY) and Procter & Gamble Co. (PG), in the way corporate bust-up artists did three decades ago.
Just for fun, we're even treated to an '80s-style insider trading case, featuring an accountant tipster at KPMG, bags of cash and Rolexes changing hands.
The elements that have carried the market here in recent months remain in place: heady credit markets, an appetite for shares of stable cash-rich companies, a good-enough economic picture, an abiding reservoir of investor anxiety that’s keeping speculative excesses in check.
The short-term challenge is that the indexes are sitting on the same year-to-date gain as they were a year ago, at a time when the seasonal winds will turn against stocks. The leading sectors such as staples and media stocks are looking stretched and pricey, hinting they should give way for a while, perhaps to more growth-dependent groups. And, finally, alerts are raised for another springtime sag in the economic data.
Any or all of these items could easily break wrong to bring on that long-deferred gut check. (The Dow did drop more than 10% over several months in 1984, after all, interrupting the uptrend.) Yet as long as the credit markets hold rock-steady and investor attitudes remain this side of giddy, the ‘80s-like synth-pop rally merits the benefit of the doubt.