With John Hampson
1937 was a solar maximum, like 2014, and notably the stock market peaked out despite negligible interest rates and with preceding QE, i.e. it was an atypical bull market end: easy conditions, no over-tightening. Stocks were run up on relatively thin volume and low participation to a Q-ratio valuation of over 1, in a 5 year rally. Stocks topped out 1 month away from the smoothed solar maximum without any notable trigger event. They had front-run a significant pick up in earnings and the economy that failed to materialise, and later in 1937 the US economy slipped into recession.
2014: we have had a 5 year rally since 2009, set against ZIRP and QE. Stocks have been run up on low participation to a Q ratio valuation of over 1, front-running a return to ‘normal’ earnings and economic growth that demographics suggest will remain elusive. In 1937 the thin volume allowed the market to rise easier, but then also to fall easier, and we have the same low volume now. Speculation should peak out close to the smoothed solar maximum, which looks most likely to have been around February. Unless the sun get busier yet, then we might expect stocks to be topping out. Evidence from sentiment, euphoria, divergences, leverage and asset allocations suggest this is indeed likely.
The weak economy and exuberant stock market are at risk of a deflationary shock, but failing that, realisation that 10% earnings growth and over 3% GDP growth are not going to happen again is bubbling under the surface. In other words, some surprise bad news could provide the requisite dent in confidence in equities, or stocks could roll over without a strong GDP print for Q2 (release 30th July) or an impressive Q2 earnings season (reporting starts 8th July).
1937 provides an example of stocks topping out on overvaluation despite easy money conditions. Other historic examples of equities front-running to over-valuation were also resolved by a bear market. Timing the top in 1937 came down to pinpointing the peak in the sun’s activity, and I believe this is the same challenge in 2014.