New highs might be good for market

The S&P 500 continues to hover just below May 2015’s all-time highs, but investors could be forgiven for thinking a breakout will never happen, given the amount of times over the last year the index has retreated from current levels. If new highs are set, however, patient investors may be handsomely rewarded.

Technical analyst Jonathan Krinsky of MKM Partners notes that since 1928, there have been 20 times where indices spent at least a year without setting a new 52-week high. Once new highs were made, stocks enjoyed gains over two-, three- and 12-month periods on 19 of 20 occasions, with median returns of 6.93 per cent, 7.76 per cent and 20.8 per cent, respectively. It would, said Krinsky, be "almost unprecedented" for stocks to break out and then "roll back over into a bear market".

S&P Capital IQ's Sam Stovall makes a similar point, noting 2015-16's dragged-out decline has been the fourth-longest correction in history. Stocks typically "climb further and longer" following drawn-out corrections, said Stovall.

There is an obvious rationale for this historical tendency. Stocks typically remain in long trading ranges for specific fundamental reasons; when these obstacles are removed, there is obvious potential for strong, sustained breakouts.

The ongoing earnings recession is the obvious obstacle today. Until earnings improve, stocks will likely remain in their range. If profits pick up, however, expect decent follow-though.

Blackrock’s caution on equities

Blackrock, the world’s largest money manager, doesn’t envisage a breakout to new highs any time soon, judging by last week’s decision to downgrade global equities to neutral on the basis they “no longer look cheap”.

Blackrock is right to point out that the MSCI World Index’s 14 per cent rally since February leaves equities vulnerable to short-term risks such as rate hikes, Brexit, a global growth scare or any other unexpected development. If anything, its warning that US valuations “sit around the 70th percentile of their long-term historical range” may be an underestimate, depending on what valuation metric is used.

However, while global equities may "no longer look cheap", many regions don't look especially pricey either. The book value of European stocks, Wall Street Journal columnist Jason Zweig noted recently, is roughly 40 per cent below US equities, while emerging markets' (EM) book value is half that of the US. Both Europe and EM also sport much bigger dividend yields than the US.

Equities everywhere have rallied in recent months, but Europe and EM both remain nowhere near last year’s highs.  There are good reasons for that, but the strong global rally off the February lows should not blind value-conscious investors to the fact that many indices are not nearly as elevated as others.

Risk of Brexit less than it appears

Brexit worries have returned, with sterling tumbling last week following polls showing an unexpected lead for the Leave camp.

Bookmakers responded by slashing the odds on a Brexit; Pimco cautioned of a "significant" risk of Brexit, saying the odds of a Remain vote were around 60 per cent; influential Citigroup economist Willem Buiter said he was "increasingly concerned"; London-based Hermes Investment Management warned investors to "brace themselves" for a possible Brexit.

It’s worth noting, however, that only a slight jump was registered in polling analyst Matt Singh’s Number Cruncher Politics Brexit Probability Index, to 22 per cent. The polls may appear tight, but people have an inbuilt status quo bias, and that is likely to result in voters becoming more risk-averse closer to polling day.

Betting on a Remain vote is an asymmetric bet – stocks and sterling would lose much more from a Leave vote than they would gain from a Remain vote – but it’s a lot less risky than recent polls might suggest.

‘Avaricious’ traders eyeing Brexit polls

Talking of Brexit, Labour deputy leader Tom Watson is unhappy that hedge funds are apparently commissioning private exit polls to help give them a heads-up on the results, saying "avaricious" financiers should be banned from benefitting "from information that belongs to every voter".

One expects populist guff from politicians, although this is an especially remarkable example of same. It would be an odd situation if people – even the “privileged few” – were not free to carry out their own research. Market professionals will always have an inherent information edge over private investors because they have deeper pockets; that may seem unfair to some, but prohibiting investors from commissioning private surveys is a little North Korean.

Ironically, their information edge is actually less pronounced in this instance – everyone has access to opinion poll trends, while referendum exit polls are notoriously unreliable.

In numbers

53: Amazon’s percentage advance since February 8th.

340: Amazon’s market capitalisation, in billions of dollars, making it the sixth-biggest US company.

297: Amazon’s trailing price/earnings ratio.