Ned Davis, president and senior investment strategist of the Florida-based institutional research firm, correctly forecast last year’s market decline.
In February of this year, he called the market rally that began in March.
Now, he says, that cyclical bull rally is not over - we agree, but understand the easy money has been made now it should be about stock prices correlated with fundamentals.
Davis, who is in his fifth decade as a market forecaster, spoke at last week’s Financial Advisor Symposium in Orlando, Florida.
He synthesizes technical, fundamental and macroeconomic analysis into a solid repeatable process uses seven indicators that correspond to secular market lows. Most of those are not in place, and he offered a neutral long-term forecast.
Advisor Robert Huebscher reports on November 17, 2009:
The cyclical bull market is not over: A Few of Davis' Bullish Indicators
- “Big Mo” indicator, which measures momentum across 100 industry segments, had reached an extremely bullish level of over 90 at the end of October, but it has since receded to 85, which Davis said is “moderately bullish.” This level is consistent with a cyclical bull market, he said.
- The recent steep fall in corporate bond yields. Such declines typically coincide with rising equity prices.
- Noting that points of extreme investor pessimism typically coincide with the onset of market rallies, he showed that his sentiment indicator reached its lowest point (30.9) in March, a very bullish signal. But that indicator now is 60.0 and signifies optimism, suggesting that investors should “take some money off the table.”
- Another bullish signal is that stocks do well when inflation is low. Davis presented data showing that stocks gained 18.1% when inflation was under 1%, 8.7% when inflation was 1% to 4%, 1.2% when inflation was 4% to 9%, and 0.7% when inflation was over 9%. His data reach back to 1947, and thus do not include the deflationary periods during the Depression, which many claim closely resemble today’s environment.
“A strong tape, corporate yields still falling, sentiment not showing extreme optimism, and low inflation are a pretty bullish signal,” Davis said, adding that “at this point in time we don’t have any evidence that the cyclical bull market is over.”
Foundations of a secular market low: Don't Know.
Secular trends, or super-cycles, encompass multiple cyclical market cycles, and Davis said they can last as long as 20 years. On a secular basis, Davis is neutral, based on his analysis of seven “foundations” of secular market lows.
1. Money should be cheap and readily available, as it is today. Davis showed that secular bear markets consistently correspond to periods of negative growth in the real money supply; currently, the real money supply is growing by nearly 8% annually – a bullish signal.
Monetary growth has not translated to increased bank or consumer lending, which Davis said is necessary for this foundation to be solidly in place, and he concluded that this foundation “is not consistent with a secular low.”
2. The debt structure should be deflated, but his data show that total public and private sector debt is at its highest level ever, and has been rising consistently since 1990, as shown below:
“This is the most negative chart that we have,” he said.
The ratio of the increase in debt to increase in GDP has risen in each decade since the 1950s, nearly doubling to 6.03 in the current decade from 3.12 in the 1990s. He also noted that, for the first time in history, combined federal, state and local government debt now exceeds GDP.
3. Pent-up demand is Davis’ third foundation for a secular low. Davis’ data showed that demand had risen steadily since 1985 but fell off over the last year. It rose slightly during the last quarter, which he attributed incentive-based programs, such as “cash for clunkers” and the government’s first-time home buyer program.
4. Fundamentals are the core of Davis’ fourth foundation, and he said the market valuations are neutral based on “time-tested, absolute valuation methods.”
5. The fifth foundation is that investors should be “deeply pessimistic” about the market and the economy. On that measure, Davis said advisor sentiment has turned positive and objectively generates a sell signal, but he believes that sentiment could get even more positive before the market turns down.
6. Davis’ sixth indicator is that “major investor groups should have below-average stock holdings and large cash reserves.” Foreign investors have equity holdings well below their median value, but individual investor holdings and institutional holdings (excluding mutual funds) are just slightly below their historical median. “I don’t think institutions are really in shape to go on a big buying binge,” he said, and he rated this category neutral.
7. The final factor is “a fully oversold longer-term market condition in terms of normal trend growth and in terms of time.” Davis presented the following data:
Oversold but not as oversold as the 70s and early 80s or the 30s. Neutral again.
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