There is little surprise that stock investors are jittery as the U.S. extends the longest U.S. economic expansion on record and after a stratospheric 330% stock-market gain during the run, including an almost 17% year-to-date total return.
Bulls insist this economic and market expansion is built like no other, meaning that its demise won’t come about in a way that has taken down past bullish phases.
Among the optimistic, Jim Paulsen, chief investment strategist with The Leuthold Group, says true bullish buying interest has yet to take hold on Wall Street. Rather, the bull market has thus far been propped up by defensive, even reluctant, investing and mostly by institutional interests over true volume from average investors.
What’s more, job growth took a while to take off and record-low interest rates have stuck in place well into the late years of the recovery.
Stock bears, on the other hand, are tallying signs of market and economic fatigue, including 2% GDP stall-speed and emerging weakness in China and Europe. These shifts, they stress, are playing out against quiet — perhaps too quiet — volatility.
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Paulsen’s preferred bullish-case incentive can be drawn in a chart that compares gold prices GCM9, -0.26% which are typically a proxy for fear, against small-cap stocks RUT, -0.36% which are reflective of domestic growth. Right now, the chart shows that this particular sentiment-measuring “wall of worry”— even though it’s at one of its highest levels since 1970 — isn’t about to translate into a breakdown of bullish sentiment soon, leaving markets more room to rally without overheating, he said.
Read: Cyclical stocks are back in vogue as recession fears fade
“Better values, lower yields, a pause in overheat pressures, accommodative economic policies and fear. A nice foundation for record stock market highs to come,” insists Paulsen.
Here’s how that gold and small-cap coupling — calculated using the price of gold relative to the overall commodity price index divided by price performance of small-cap stocks relative to large-caps — appears when charted:
When the ratio is high, it connotes investment behavior that is fearful, and a low ratio suggests investor confidence. Historically, when this gauge of worry has been top quintile, forward 13-week average annualized stock returns are about 18.5% compared with 10.5% the rest of the time, Paulsen explains. Moreover, the frequency of a negative forward 13-week stock market decline has been only 25% compared with 37% the rest of the time.
Chart 2 illustrates the S&P 500 forward average annualized 13-week percentage price change for each “worry-gauge” quintile since 1970. The red line represents the percentage frequency of negative forward 13-week price changes. From at least 1970, there has clearly been a relationship between “worry” and the future risk and reward profile of the stock market.
So, what’s different this time? The near-term factors that could keep the major stock indexes supported for now include a price-earnings multiple, a popular measure of equity valuations, for S&P 500 SPX, +0.10% constituents that is, by at least one measure, only slightly above average since 1990 and a 10-year Treasury yield TMUBMUSD10Y, -0.38% that is well off its peak hit last year at 3.25%. That makes the relative valuation of stocks compared against rates offered for government paper more attractive.
“The economic slowdown in the first quarter brought the policy cavalry. Both monetary and fiscal policies within the U.S. and about the globe are now fully supportive of stocks and future economic growth,” Paulsen emphasized.
He offers this additional note of prudence: “Stay appropriately cautious but don’t invest scared.”
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