Stocktake: Tired bull may get second wind

The chances of Brexit as short sellers spook executives

Tired bull may get second wind

Investors could be forgiven for thinking that the seven-year bull market has, as billionaire investor Stanley Druckenmiller put it recently, "exhausted itself".

Despite advancing last week, the S&P 500 remains stuck in a trading range and it has now been more than a year since it made new highs. Contrast that to 2013, when 45 new highs were registered, and to 2014, when it hit new highs 53 times.

The bull market is elderly – it is the second-longest in history – but investors should remember that bull markets tend to go out in a blaze of glory rather than fading away.


There have been six instances since 1955 when bull markets endured similar droughts, according to LPL Research; on each occasion, stocks were higher six and 12 months later, registering average gains of 12.5 and 20.5 per cent respectively.

“Not going up does not mean going down,” to quote Birinyi Associates, which compares the current impasse to the old Rolls Royce advert boasting that its cars don’t break down; rather, they occasionally “fail to proceed”.

Checklist suggests caution

Further evidence that the old bull may still have some life left in it is provided by Strategas Research, which keeps a checklist designed to measure the health of the bull market.

Peaks are associated with heady market sentiment, characterised by much IPO activity, heavy equity inflows, and a parabolic move higher (or a “blow-off top”, as Strategas put it).

Sentiment remains muted today – indeed, just 18 per cent of investors describe themselves as bullish, according to the latest American Association of Individual Investors poll, a reading seen just four s over the last 25 years.

There are some warning signs, notably waning earnings, widening credit spreads, a declining number of stocks making new highs, and a shift towards defensive stocks.

The checklist “signals caution”, says Strategas, “but no need to panic”.

Little chance of Brexit

Fund managers and market strategists may be fretting about the Brexit threat but the collective judgment of so-called superforecasters suggests they need not worry.

Superforecasting, the bestselling 2015 book by predictions expert Philip Tetlock, argued that while most "expert" predictions are no better than chance, accurate forecasting is possible if people take a probabilistic, data-driven approach.

Good Judgment Inc, a panel of superforecasters that follow Tetlock's model, last week estimated the odds of Brexit to be just 11 per cent, down from 37 per cent in April.

Wall Street may be belatedly catching on to the merits of a more rigorous forecasting method.

Last week, Goldman Sachs referenced Tetlock's work, saying it would adapt an odds- based approach to Federal Reserve interest rate policy, making "judgmental probabilities" and actively managing probabilities in response to new information.

Investors can keep up to date with the thoughts of the Good Judgment superforecasters on Twitter; its odds-based assessments of Brexit and other global issues are likely to be infinitely more useful than the subjective commentary emanating from the usual financial channels.

Yield drives up dividend stocks

"We're in the first inning of shifting to dividend-paying stocks," said high-profile finance professor Jeremy Siegel last week, his reasoning being that investors must be attracted to income-producing equities in a low-yielding world.

“First inning”? Really? Investors have been reaching for yield for seven years now, driving up the valuations of dividend stocks in the process.

High-dividend payers have traditionally been good investments, the main reason they tend to be somewhat risky, out-of-favour firms whose undervaluation results in eventual outperformance.

However, while such stocks once traded at a discount to indices, they trade at a premium to the S&P 500 today, despite the fact that many are low-quality companies that score poorly on profitability metrics such as return on equity (ROE) and return on assets (ROA).

You don’t get high yield without taking on higher risk. The move into dividend stocks in recent years has been an understandable one, but those stocks are now riskier than most. Caveat emptor.

Execs spooked by short sellers

Short sellers keep companies honest; in fact, the very idea of short sellers is enough to make companies clean up their act.

That’s according to the authors of Short Selling and Earnings Management: A Controlled Experiment, a new Journal of Finance paper that examines the effects of a pilot programme between 2005 and 2007 whereby regulators loosened short selling restrictions on one-third of stocks in the Russell 3000 index.

Discretionary accruals, where firms set aside funds for future liabilities, decreased; so did the likelihood of companies marginally beating earnings estimates; companies improved their financial reporting.

Short sellers tend to be good detectives, as company executives well know. The mere prospect of this detective work, it seems, is enough to keep them on the straight and narrow.