I’m Not Dead (Yet) – US Equities Through Year-End – Tiburon Capital Management
I’m not an unrepentant bull, nor a doomsday scenarist. But when I hear the punditry around a coming US equity markets correction, it reminds me of the scene in Monty Python and the Holy Grail, where a cart is pulled through a muddy village, to the cry, “bring out your dead!”
A man comes out with a dead-looking old man in a nightshirt slung over his shoulder. He starts to put the old man on the cart.
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Man: Here’s one…
Cart-master: Nine pence.
Old Man: (feebly) I’m not dead!
Cart-master: (suprised) What?
Old Man: I’m not dead!
Cart-master: ‘Ere! ‘E says ‘e’s not dead!
Man: Yes he is.
Old Man: I’m not!
Cart-master: ‘E isn’t?
Man: Well… he will be soon – he’s very ill…
Old Man: I’m getting better!
You get my point. So with the most common equity markets concerns stoked by an imminent rate hike (we see 2Q15), shouldn’t there be some historical data to reflect upon to help determine timing? We will discuss this, framing the discussion in terms of cycles or a clock.
Coming Rate Hike 2Q15
When the FOMC does eventually raise rates, it will be the first change in rates since December 2008 and the first hike since June 2006. There is historical data that suggests that while rate hikes have historically led to greater volatility in equity markets, they have not marked the end of equity bull markets. On average 6 months after the first rate rise equities have risen 3.7%.1 In fact, three of the four monetary policy turning points, within 18 months, the S&P 500 rose by at least 10% from its level when rates rose (with the S&P gaining around 10% in just one month following 1986’s rate rise). The one exception was 1977, when it took two years to achieve a 10% gain.
A coming rate hike is common market perspective. It has been our view that a gentle rate rise in the US, coupled with reasonably good US economic data and dynamics as we entered 3Q14, should suggest that credit spreads inevitably turn up but equities rally on further increases in EPS. This “phase” lasted another 1-3 years in the 1980s and 1990s. In the last cycle it only lasted 4 months. During such a phase, equity markets volatility should rise. Typically such markets await bubbles and see outperformance from large-cap and cyclical stocks. This profitable but increasingly unstable period ends when global EPS turns down. We do not think this moment is imminent but where are we on the phase or cycle calendar or clock?
Market Clock – What Time is it?
Whether it’s the best of times or the worst of times, it’s the only time we’ve got. – Art Buchwald
It is our view that a rate hike occurs in 2Q15. Further, that based upon historic evidence coupled with reasonably good US economic data, that US equities can appreciate between now and year-end 2014. We find further support for our estimated timing in recent work by Citibank Research equating the market to a clock and breaking market cycles into four (4) phases. It appears and feels like we are in and around what they describe as “Phase 3”. During Phase 3, the credit bull market ends, spreads start to rise as investor appetite for rising leverage wanes. But the equity bull market continues as profits and CEO risk appetites rise further.
Citi’s work looks back at prior equity and credit cycles in this fashion. Spreads rose by around 300bp in 1988-90 and 1997-00. Spreads rose 126bp in 2007. During a Phase 3, to their (and our thinking) the credit bear market begins, but the equity bull market continues. Citi’s work suggests that it is usually too early to sell equities at this point. Equities rose another 30% in 1988-90, 50% in 1997-00 although they only rose another 3% in 2007.4 The current economic data in the US, to our thinking, also supports this.