Don't Stop Me Now
by Zach Marsh on Jan 10, 2020
The market continued its march higher this week, with the S&P 500 gaining another 1.5%. Since December 3rd the S&P 500 has now risen over 6%. The move in the large cap index is reminiscent of the rally from December 2017-January 2018. That move two years ago saw the S&P 500 rally over 9% in just about a month and a half, before the floor fell out and the market dropped 10% in two dramatic weeks. Can this current move be more sustainable, or are each of these periods of elevated growth necessarily followed by sharp reversals?
To recap the situation in January 2018, the 9% rally in a month and a half capped off what amounted to a 2-year market rally of over 52%. Currently, this rally from the December 2018 lows has seen the market rise over 39%. In January 2018, the Federal Reserve, with a new Chairman coming onboard, was signaling that it was intent on continuing to raise interest rates and reduce its balance sheet. As we stand today, the Fed’s last rate hike was in December 2018, and in October 2019 it launched another version of capital injection into the marketplace. This latest version of Quantitative Easing is more opaque and lacks a definitive timeframe for its removal.
The main harbinger of when the latest market party will end may be an indication from the Fed that it is getting ready to remove the punch bowl. Should the Fed start to signal that it is worried about market valuations or seeing signs of inflationary pressure starting to build that would be an indication that the lights are about to come on and the party beginning to break up. In the past, Fed Chairs have not been shy about weighing in on current market valuations. Chairman Greenspan famously called the stock market irrationally exuberant back in December 1996. Chair Yellen in July 2014 commented specifically on valuations of social media and biotech stocks, calling them “substantially stretched.”
Neither of these calls on valuation proved prescient, the S&P 500 rallied 92% in the 19 months after Greenspan’s “Irrational Exuberance” call and the Biotech ETF XBI rallied nearly 90% in the year following Yellen’s valuation call. Talk about being fantastically wrong. But it’s not so much what they say as much as whether they back it up with action. In the months following Greenspan’s comment, the Fed raised rates only one more time (that being in March of 1997). After Yellen’s valuation call, the Fed’s target rate remained at 0% for another 15 months.
There seems little doubt that valuations are high right now. It would hardly be a shock if someone in the Fed made that comment. But as long as the actions of the Fed remain accommodative then the rally that’s been going on for over a year can continue for awhile longer. As another famous economist, John Maynard Keynes, reminds us, “Markets can stay irrational longer than you can stay solvent.” And it seems that in the last 70 years market irrationality tends to be more extreme on the upside rather than the downside.
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