With global growth slowing, global trade tumbling, and earnings revisions falling rapidly, equity market outperformance has been (as we noted earlier) based on the Fed/ECB's largesse. The unanswered question is - how much is now priced in? Given recent 'stability' post-FOMC, it seems the follow-through is not there (especially if we look at sectoral performance) and based on David Rosenberg's estimate of Fed QE's impact on stocks, we think we know why. In the last three months, the S&P 500 has 'outperformed' the Fed balance sheet by around 220 points - which equates to a pricing-in of around 11 months of additional QEternity.
S&P 500 vs Fed balance-sheet...
Via David Rosenberg:
As I have said in the past, there are six different factors that drive the equity markets at any given point in time, and in some periods, one or a few factors dominate, and in other periods, these same drivers can be on the back burner.
These six items are liquidity, fund flows/positioning. technicals, valuation, sentiment, and the fundamentals. They continue in the aggregate to provide a very murky picture, but the fact that the market has hung in following last week's massive gains tells me that the first two factors are dominant at the present time.
The Fed has bolstered investor confidence with its massive monetary easing, even if it doesn't work for the real economy - our research from the past three years shows that every $40 billion of QE boost (QE3 at a pace of this amount per month) to the Fed's balance sheet, as a static stand-alone event, adds about 20 points to the S&P 500. Then there is the fact that the hedge funds, in aggregate, have lagged so far behind this year that they will be forced into the market to avoid embarrassment - and redemptions - at the end of the year. We are hearing some hints of some asset mix shifts taking place among institutional investors too. Technicals, as far as I can see, are neutral (though improving over the past week) as is valuation though forward WE ratios are at the high end of the range for the past 20 months at 14x (and the Shiller cyclically adjusted multiple is 25% above historical norms).
Sentiment and fundamentals remain the two primary sources of downside risks. On the latter, operating profits are now declining in tandem with reported (GAAP) EPS and guidance overall is to the negative side and by a larger than usual margin (four to one). Analyst downgrades are outpacing upgrades. I look at FedEx as a cyclical bellwether and shipments are contracting. As for the former, the bull camp is getting crowded — problematic from a contrary standpoint.
At the June lows in the S&P 500, the Investor's Intelligence Survey flashed just 34% bulls — that number as of this latest week is up to 54.2% (from 51.1%). The bear share fell to 24.5% from 25.5% and is actually lower now than it was when the market was carving out an interim bottom in early June. Take note that the bull/bear gap has widened out to 29.7 points from 25.6 points last week and 7.4 points in early June (when sentiment was very low and the VIX was at 26 versus 13-and-change today) — a spread of over 30 in the past typically characterized an over-extended market ripe for a pullback: and bullish readings of 55% or higher in the past was a warning flag for those investors playing from the long side.