war room 27 mar 2013 the great rally – is the ride over?

War Room 27 Mar 2013

The Great Rally – Is the Ride Over?

War Room•Monthly macro discussion

•Using tools in context

•Update on HiddenLevers Features

•Your feedback welcome

The Great Rally

I. Historical Comparisons

II. 2009-2013 Rally in Context

III. Sector Analysis

III. Scenarios + Macro Themes

HiddenLevers

HISTORICAL COMPARISONS

1929-1949 1968-1980

Market Rallies: Bull Markets Compared

I’m still goingstrong

source: financialgraphart.com

• Typical bull market lasts 3-4 years

• Truly great rallies last a decade

• Current rally right in the middle of the pack

Markets: Secular Bulls + Bears since 1871

source: Doug Short, dshort.com

• Secular trends can span many market cycles

• Four bull and four bear markets since 1871

• Current (4th) bear not yet clearly over

Markets: Defining the paradigm shift

S&P Real Total Return

all-time high:

date:

When will Bear Market end?

Only when the year 2000 highs are forever left in the

rearview mirror.

163724/Mar 2000

Market Metrics at Recent Peaks

Metric 3/2000 10/2007 3/2013

P/E Ratio 28.5 20.7 18.01

Dividend Yield 1.16% 1.77% 2.12%

Q-Ratio 1.78 0.95 0.98

S&P / GDP Ratio 154.5 111.8 98.3

S&P 500 not as overvalued as it was in 2000 + 2007 (YET)

source: HiddenLevers analysis, Multpl.com, dshot.com

Bullish Historians – Market/GDP Ratio

source: Bloomberg

• Market not overvalued relative to other recent peaks

• Economy has grown so S&P is just catching up

• Buffets favorite indicator

Peaking?

Bearish Historians – Q Ratio

Q Ratio • total market

value / total replacement value of all companies

• Market peaks around 1 on Q scale

• 2000 a clear outlier

source: Doug Short, dshort.com

Peaking?

HiddenLevers

2009-2013 RALLY IN CONTEXT

Rally in Context: Inflation + USD

source: HiddenLevers

Analysis

• QE made inflation jump, but inflation has trended downward since mid-2011.

• Usually USD trades inverse to markets, but US dollar has rallied in 2013, even with QE increasing. This shows an intact decoupling story.

CPI touched 4%

USD

S&P

Rally in Context: Unemployment + GDP

source: HiddenLevers

Analysis

• We are still near 8% unemployment, a far cry from under 5% when the 2007 S&P peak. This exposes QE shortcomings

• US GDP has not kept up with the market rally. Again, QE can lift asset prices, but real growth is more difficult to achieve.

2007

BIG GAP

Shabby growth

Rally in Context: Housing + Confidence

source: HiddenLevers

Analysis

• Home sales + consumer confidence slowly rising since bouncing upward in 2011

• Home prices initially lagged, now marching up with S&P 500Housing rebound

Housing = confidence = rally

Rally in Context: QE + MarketsQE 1MortgagesAsset Backed SecuritiesAny toxic Asset

QE2US Treasuries

QE3Agency backed mortgagesContinued buying(equities)

Yeah baby!

QE Scenarios: How did we do?

slide from Sept 2012 War Room – QE3# success

# fail

10y S&P unemployment

USD index US GDP

# TBD

Still the case

SECTOR ANALYSISHiddenLevers

Sector Analysis: Strongest

Telecom = 21%

Healthcare = 20%

Discretionary = 17%

52 week change on S&P

Defensive sectors doing best

Usually, defensive sectors don’t lead rallies.

Residential construction has outperformed with the turn in housing

Consumer Discretionary contains all of residential construction and related industries

11%

Sector Analysis: Weakest52 week change on S&P

Tech… Apple effect?

Google at 52 week highsApple at 52 weeks lows

Inflation has been in check

GDP growth sluggish

Materials + Energy have no reason to lift off

11%Tech = -2.6%

Materials = 5%

Energy = 8%

SCENARIOS + MACRO THEMESHiddenLevers

Scenarios: Rally Killers

How will QE end?

1 2

Europe’s crash test dummy

GoodEconomy

back on track

BadStagflation

UglyDeflation

strikes back

Scenarios: End of Quantitative Easing

US Dollar gains in

all outcomes

GoodDebt Crisis

Averted

BadCyprus

Contained Meltdown

UglyCollapse +

Currency Run

Scenarios: Euro Zone Debt Crisis

EU leadershipbiggest mistake

Pulling Euros out of depositor accounts

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