Looking past the election confusion, this piece considers several fundamental parameters and assesses the underlying conditions that the stock market is responding to today and how it is likely behave in the future.
Peaks in the high-yield spread index (ICE BofA US High Yield Option-Adjusted Spread Index) correspond with lows in the SPX (chart below).
The recent SPX low was confirmed by the peak in the HY spread, and the subsequent recovery rally resulted in a new low for the HY spread which demonstrates the firmness of the rally (chart below).
Industrial Production and Corporate Profits
Changes in industrial production tend to lead the SPX. The pandemic “sink-hole” is being filled, and the market knows it. The bull trend in the stock market remains fundamentally in place (chart below).
The GAAP earnings fell “off a cliff” two quarters ago, but the RSI of the GAAP has flattened in oversold territory and is set to recover soon (green vertical lines on chart below). Judging by the corporate taxes collected so far this fiscal year – which are +18% higher than they were at the same time last year – we expect corporate profits in the current quarter to show that a significant recovery is in place.
Valuations and Rates
Our preferred method of evaluating the SPX is to subtract the six-month Treasury yield from the SPX dividend yield to get the “net yield”. By this measure, stocks are historically cheap (chart below). Further, the profile of the net yield is similar to 1995 and 1998, just before two explosive, multi-year rallies in the SPX. We continue to expect that a new technological revolution is taking hold which will send the stock market to levels that few people can imagine…just like in the late 1990s (chart below).
The charts below show that from the perspective of the Fed funds rate and the various rate differentials, the market is setting up for a massive bull run like it did in the late 1990s, which should last for several years and produce huge price increases in stocks. .
Sovereign Deficit Spending
Reduced deficit spending always precedes recessionary periods (red outlines below). Throughout the 1990s, Clinton reduced the deficit and finally eliminated it, sending the budget into surplus.
Since government surpluses = private sector deficits, during Clinton’s reign, the private sector had to take on bank debt in order to continue to grow the economy. However, since bank credit “money” has to be paid back with interest, in 2000, the bubble burst when the private debt burden could no longer be carried.
The current situation couldn’t be more different; the government deficit, combined with low interest rates, is making it possible for the private sector to have historically low levels of debt (chart below). (More in-depth reading here).
This current stock market is fundamentally set up for a technology-based bull market that could be monstrously bigger than in the 1990s.
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Disclosure: I am/we are long IWM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.