The bull market that few people believe in
Top 3 drivers of global rallies ― liquidity, corporate earnings, and risk appetite
By Kim Jae-kyoung
You may not feel it but a bull market has come back on stage. Although investors and policymakers are not so sure or are little aware of it, we have just lived through one of the greatest bull markets in history. The U.S. stock market has hit a five-year high, while European markets are behaving as if everything is fine.
Despite lingering uncertainties seizing the world economy, the global financial market has weathered numerous challenges and has continued on an upward spiral. Market rallies are being spotted worldwide — North America, South America, Europe and Asia. Bolstered by strong performance abroad, the domestic market has also enjoyed a sustainable ascent.
Last Wednesday, the U.S. stock market had its biggest gain of the year. Both The Dow Jones Industrial Average and the tech-laced NASDAQ composite index broke the psychologically-important levels of 13,000 and 3,000, respectively.
The Dow closed at 13,177.68 on that day, the highest level in 50 months, while the NASAQ ended at 3,039.88, the strongest since 2000. Standard & Poor’s 500 also surged to 1,395.95, its highest level in 46 months. Europe stocks also rose to their highest level in eight months.
The key reason for omnipresent rallies is the revival of risk appetite among global investors. Risk-loving investors, who scrambled for an exit from stock markets following the outbreak of the eurozone crisis, are returning. The CBOE (Chicago Board Options Exchange) volatility index, known as the “fear gauge,” which reflects investor anxiety, fell to a nearly a five-year low Tuesday.
There are three key triggers that have been stimulating risk appetite. Fears of the eurozone debt crisis spinning out of control have been eased, turning around investors’ sentiment. Besides, global companies Apple and Volkswagen surprised the market with impressive earnings. Finally, central banks around the world have kept channeling new liquidity.
Bearish observers are issuing warnings against optimism saying that financial markets are overheating today. However, a growing number of investors and analysts are moving into the optimistic camp believing that there is still much room for stocks to move upward.
“I have been, and remain bullish. The rally is based on the recovery of the U.S. economy, against the background of the rising power of China and the other BRIC economies,” Goldman Sachs Asset Management Chairman Jim O’Neill told Business Focus via email from London.
“Of course stimulative policies of the major central banks are also supportive. I did and still expect a 20 percent rally of the S&P 500 and other major markets in 2012,” he added.
The bullishness in the current market is widely considered a liquidity rally. Central banks’ liquidity injections over the past year are now making their way through the real economy.
The European Central Bank (ECB) is estimated to have supplied 1 trillion euro ($1.3 trillion) to banks in the region through its long-term refinancing option (LTRO), which allows banks to raise funds for three years at 1 percent. This is the reason why European investors turned to “buy mode.” The U.S. Fed has extended its commitment to keep near zero interest rates up to 2014, while the Bank of England expanded its quantitative easing (QE) program.
On Tuesday, the Bank of Japan (BOJ) kept its key interest rate unchanged at between zero and 0.1 percent, while boosting a loan program by 2 trillion yen ($24.4 billion) to 5.5 trillion yen. The Japan Bank for International Cooperation has decided to extend low-interest dollar loans to Sony Corp. and Toshiba Corp. through major Japanese banks to help finance their acquisitions of foreign companies
A shift toward monetary easing is also the trend in many emerging countries — China, Brazil and South East Asia. Brazil’s central bank opted for an aggressive 0.75 percentage point cut, to 9.75 percent, at its most recent rate-setting meeting on March 7. The Reserve Bank of India kept its policy repo rate on hold at 8.5 percent Thursday. It also lowered reserve requirement ratios by 0.5 percentage points.
Market analysts say that central bank stimulating policies helped ease some global fears, which have been omnipresent until recently.
“With central banks continuing to push for growth, it is reasonable to expect further capital inflows and a further liquidity-driven rally. On the domestic front, most economic data releases support monetary easing action, especially as inflation has been easing,” Natixis economist Edgardo Torija-Zane said.
Another key engine for the recent market ascent is improvement in global firms’ performance. Global technology giant Apple and Volkswagen of Germany recently announced record results, giving further momentum for markets to fly higher.
Apple posted net profits of $13.1 billion in the first quarter of fiscal 2012, up 118 percent from a year earlier, which further boosted its shares. Apple stocks have risen by 30 percent this year, helping the NASDAQ blast above the 3,000 milestone.
Volkswagen recorded operating profits of 11.3 billion euro, leading the rise of the German stock market. The DAX went over 7,000 Wednesday for the first time in eight months.
South Korea’s tech giant Samsung Electronics also posted 165 trillion won (approximately $146 billion) in annual sales and 16.2 trillion won in operating profits last year. The sales figure is the highest-ever in the company’s history. Samsung Electronics shares hit a record high of 1.25 million won Wednesday.
Market Force Company CEO James Rooney points out that earnings surprise by global players, particularly Apple’s handsome performance, is buttressing the market rise.
“Apple’s continuing success and the reflection of that success finally are starting to show up in their market valuation — now over $544 billion, up from less than $400 billion just months ago,” Rooney told Business Focus.
In fact, shares of Apple, getting a boost from anticipation of the new iPad, passed $600 at one point in Thursday’s trading session. The rise gave the company a market valuation of about $552 billion. Apple started selling the new iPad Friday.
“And presumably that success will continue to flow through to the many suppliers and distributors that are riding the Apple Wave, as well as secondary effects that will start to show up in various forms of higher productivity and greater efficiency of other economic activities that are able to extract serious benefits from the iPad effect,” he added.
Investors are also betting on earnings improvement, believing that U.S. and European economies will bottom out this year.
“Growth optimism is behind the rallies. The optimism is due in part to G3 central banks turning more accommodative since late 2011. The rally is sustainable as long as the data support the growth optimism,” ING Group senior economist Tim Condon said.
Light at the end of tunnel?
The last key driver that has turned around the global market is Greece getting out of default territory. The country has secured another bailout and avoided a messy default on its debt obligations.
Global ratings agency The Fitch upgraded Greece Tuesday to B minus from “restricted default” after Athens carried out the biggest debt write-down in history in a bond swap with private creditors.
The ratings agency said that Greece is no longer in default but slow reforms, political uncertainty and recession could push it back toward bankruptcy. The lift was the first such move by a ratings agency to get the country out of default territory after the debt swap cut Athens’ debt mountain by about 100 billion euros.
It was the first time Greece’s rating had been raised since the debt crisis erupted at the end of 2009 and the first Fitch upgrade since 2003, but the B minus rating still places Greek government bonds in “junk status.”
With debt fears eased in the region, yields on Italy’s 10-year treasury bonds dipped to 4.86 percent Wednesday from the 7 percent level. Yields on Spain’s treasury bonds also fell to the 5 percent range.
The economic backdrop in the eurozone is also showing signs of improvement. The Mannheim-based ZEW economic think tank’s monthly survey of economic sentiment jumped to 22.3 in March from 5.4 the previous month, the highest level in 21 months since June 2010, supporting hopes that Europe’s largest economy has recovered from a weak patch.
The think tank said that surprises for German businesses will be positive and that the worst for the eurozone banking sector was widely seen as over.
Global economists have turned more upbeat about the financial market but they still remain cautious about forecasting its future course, saying that there are still plenty of challenges preventing a recovery.
Cautious optimism prevails
They point out that only if economic indicators in major countries such as the U.S. and Europe continue to improve, will the current rally be sustainable.
“The current rally is mostly just being driven by relief from the downward pressure that have previously been coming out of Europe. So it is a rebound and not likely to have sustainable energy beyond that. There are just too many challenges and uncertainties still embedded in both the U.S. and European economies,” Rooney said.
“The market is also still constrained by fears of slowing growth and internal economic challenges for China.”
Condon of ING echoed the view, saying, “The G3 economies — the U.S., European Union and China — are not growing fast enough to be able to withstand an adverse impact like an oil shock. If growth falters, the return of double-dip worries would likely end the rally.”