April 30, 2014
The first quarter of 2014 was a strong quarter for the S&P/TSX especially compared to the S&P 500. This comes as no surprise to us. Rather than trying to forecast where markets are headed we use money flow indicators to show us where the money is heading. Back in the 3rd quarter of 2013 we noted that the S&P/TSX was gaining relative strength from the S&P 500. This has continued into 2014, historically these term trends tend to last 12-24 months. After underperforming since 2011, it looks like the S&P/TSX might be headed for a multiyear period of outperformance.
Economically, things continue to improve in the US. As goes the US so goes the world as the largest economy tends to dictate the direction of world economics. As you can see from the chart below the US Leading Economic Indicators continues to improve after the recession and financial crisis of 2008 and 2009. LEI historically has peaked roughly 6-9 months before the start of a recession.
We are now in year 5 of the bull market which began in March of 2009. Back then few would have believed that we would be at new highs for many of the world’s equity markets. Historically, the average bull market lasts for just under 5 years. So should we be worried this bull market may be ending soon? Well bull markets don’t die of old age, they often end as a result of a recession or monetary conditions changing. A few things that are worth keeping any eye on to evaluate the health of the markets and the longevity of the market are margin debt and price to earnings (P/E) ratios.
As investors become comfortable with a bull market, they increase the amount of margin debt (borrowing against stocks) they hold in their investment accounts. The last two times that margin debt has had a rapid spike up, it has helped to signal the top in the markets. As you can see from the chart below, we must keep our eye on margin debt as the level just surpassed the previous two tops and a spike higher could give us a warning signal.
Valuation is also an important gauge of the longevity of the markets. While markets can trade at high levels without a market correction, when markets are at high levels they can be vulnerable to corrections if external shocks occur. Currently both the S&P/500 and the S&P/TSX are trading at P/E ratios that aren’t cheap, but also aren’t expensive. If earnings growth continues there levels can be sustained and perhaps can go a little higher. A careful eye on valuation is needed.
The top down indicators that we follow continue to be positive. While this is the case we will have the portfolios invested for growth. As we see these indicators change, we will adjust the portfolios to raise cash levels to protect against any downward market moves.