Wall Street bulls and bears have been stuck in a Cold War-style standoff this year. You might even call it a regime of “mutually assured frustration.”
These camps have fiercely differing worldviews and are vocal in trying to convert the uncommitted. But neither the market optimists nor the doomsday prophets have been bold enough to make a deep incursion beyond neutral territory.
The result has been the stultifying sideways shuffle in the U.S. stock indexes. The Dow Jones Industrial Average has been stuck between 17,500 and 18,300 for three months. The Standard & Poor’s 500 index is within 1% of where it closed on Dec. 30.
In fact, despite being up against its all-time high, the U.S. market has not penalized investors at all for having sat out the equity game for more than half a year now. Since last summer’s high set on Sept. 19, the S&P 500 is up 5%. From that same date, long-term government bonds, as reflected in the iShares 20+ Year Treasury ETF (TLT), have gained 7.5%.
For a variety of reasons, though, exasperated investors should probably stop complaining about the stalled market and learn to love the trading range as a healthy interlude. Here are several reasons the long period of idling for big stocks is probably a positive thing, on balance:
-It shows the market has metabolized some huge and potentially destabilizing moves in global asset markets without much damage.
From the middle of last year deep into the first quarter of 2015, West Texas crude oil prices were cut in half and the euro tumbled a stunning 23% (at its March low) versus the dollar. Meantime, the Shanghai stock market has more than doubled in a year.
While these rapid and radical price adjustments put a scare into U.S. junk bonds and pressured emerging-markets currencies, American stocks have been thwarted but the underlying profitability of big companies and health of the U.S. consumer lent support.
Meanwhile, the global equity markets managed to rebalance themselves after years of U.S. outperformance The stars this year have been Europe, China and other Asian markets. This is preferable to America acting as the only driver of growth and equity appreciation.
-The flattening of the indexes has kept stock values tethered to corporate earnings.
Goldman Sachs strategists note that stocks’ aggregate price-to-earnings multiple has been expanding for 42 months, since September 2011 -- the second longest such cycle of ever-richer share prices in history.
This year the P/E ratio has been growing by way of a slightly higher market supported by slightly lower earnings. Profit forecasts for the coming 12 months have slipped toward zero growth.
Because first-quarter numbers have been better than anticipated and investors are forgiving of shortfalls based on a stronger dollar and lower oil prices, the S&P has held up fine. Yet if the market were vaulting higher in recent months and growing steeply more expensive, it would raise alarms that irrational, frothy behavior were taking hold.
Not only would this steal potential returns from the long-term future, but overconfident financial markets would also prompt the ire of the Federal Reserve.
The Fed is widely thought to be wary of engendering bubbly market action, and some veteran bond investors are suggesting that the Fed wants to get moving with rate increases before long, in part to prevent financial asset values from growing more extended.The absence of market exuberance can allow the Fed to make rate decisions based more on economic evidence.
As it stands now, equity valuations are either a bit above long-term average (as Warren Buffett suggested this week) or slightly below fair value (as Appaloosa Management’s David Tepper believes), depending on who’s manning the calculator. But they are not in a perilous bubble, and credit markets likewise are firm without being as aggressively valued as they were last summer.
“The market has been resilient given the sharp reductions in earnings over the past few months,” says Keith Lerner, chief market strategist at SunTrust. That counts as a victory now that leading indicators of economic performance appear to be improving.
“This is important,” Lerner adds. “With market valuations on the high side of historical ranges, an improvement in earnings will be key for the market to be able to grind higher by year end.”
Finally, to the extent that companies themselves remain the most resolute buyers of their shares, it’s preferable for the system that they binge while stock prices stop getting much more expensive.
-The halting, equivocal sideways market has largely held investor sentiment in check, forestalling a general upwelling of greed and recklessness that can accompany a market top.
While professional investors appear to be quite fully invested in stocks, based on such measures as the National Association of Active Investment Managers survey and others, the public is unexcited and confused toward the market. The proportion of respondents to the American Association of Individual Investors poll saying they are “neutral” on stocks has remained near historic highs for weeks. A monthly analysis of TD Ameritrade Group’s (AMTD) active trader clients shows them less bullish than at any time since late 2012. And small investors continue to yank money out of U.S.-oriented stock funds.
This subdued mood among the investing class is even more noteworthy given the contrast with brightening fortunes for wage-earning Americans, as measured by the historic low in weekly unemployment claims and pickup in private-sector wages. It all fits with a swing of fortunes in favor of Main Street over Wall Street for the first time in years.
Even if the fact that the market has flattened out and shunned much drama this year is a good thing, it doesn’t help too much in predicting where it will ultimately head with its next major move.
One could easily see this sideways slog as an ominous churning pattern ahead of a more serious setback, though not much is clearly pointing to this. If a flat patch is a net positive, a truly cleansing downside correction would probably be better, even if many investors would be jarred by the unfamiliar setback.
And even if stocks are unremarkably valued now based on fundamentals, other parts of the capital markets are undergoing rare extremes. Trillions on European government bonds have negative yields, big companies are issuing debt at an unseen pace and China is engineering a public mania for stocks there.
Yet no matter how all these factors play out, it’s probably better that the Dow has been so boring during another no-growth phase of this prolonged and vexing economic cycle.