Rallies May All Be Alike, Every Crash Is Different

Photograph by Lucasfilm/20th Century Fox/Ronald Grant/Everett Collection

Is that Han Solo? Or Ben Bernanke at the controls sending the market into hyperdrive?

Bloomberg’s Whitney Kisling earlier this week looked at the U.S. stock market and found a notable milestone: the Standard & Poor’s 500 Index gains over the last 50 months match the gains of the late 1990s. That raises the implicit question: is a crash right around the corner? The likely answer, based on measures of valuation that Kisling looks at, is no. Her story carefully analyzes the differences between the market today and in the 1990s. The increases then were driven by one sector, technology, and weren’t matched by a similar rise in corporate profits.

The rally now is much broader than the 1990s technology boom. You can see that in the chart below. That shows the S&P 500 (the white line) rising neatly in tandem with the Dow Jones Industrial Average (yellow). That’s very different from what you would’ve seen in the 1990s, when Nasdaq technology companies pulled away from the rest of the market.

There is one sector that, tellingly, has outperformed the rest of the market. It’s financials; the S&P 500 Financial Sector is the purple line. Obviously one reason for this is that banking crashed harder in the first place. Another reason, though, is that part of what has fueled the market boom has been monetary stimulus. That has benefited financials most–but it has also propped up the rest of the market. The real test of whether current prices are sustainable will come when that support disappears.

When I originally posted this in the TMN newsletter, I ended here. There is another question, though, that’s worth thinking about: if shared prices aren’t about to fall, how much further does the stimulus-fueled ascent have to go?

One useful way of thinking about that comes in the work of two economists at the New York Fed, Fernando Duarte and Carlo Rosa. Duarte and Rosa look at the current equity premium, the excess returns that stocks offer over bonds. In their post “Are Stocks Cheap?” they find the premium stands at a historic high. So if interest rates on bonds rise to their long term average and share prices stay where they are, then that equity premium will return to the long-term average.

If that’s the case, then as Fed support disappears then the S&P’s climb can taper off gently. Note the “can” there. It’s also possible that the cycle of Fed stimulus and market momentum pushes the market into what Appaloosa Fund Management LP’s David Tepper recently called “hyperdrive.” In that case, all bets are off, and, much like in Star Wars, “hyperdrive” catapults you to locales that mostly turn out to be dangerous.


An earlier version of this post appeared in the Market Now daily email. Click here to register and subscribe.

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