Is the Global Rally for Real?
The bull has been marching for eight years now with no signs of weakness. In fact, the economic data keeps growing stronger, supporting the case for continued strength in the global rally. The Fed’s recent statements seem to indicate possible rate tightening to combat future inflation, as well – another sign that the markets are healthy.
Taking a look at volatility in the markets reveals that investors aren’t too worried about a correction of any kind with the VIX reading under 12 for the past month. But it’s often when nothing seems obviously wrong that the markets make a sudden turn downward. The only way to really know if the markets are growing is to check the data.
Important Market Indicators
While many investors rely on the mercurial Fed for direction, there’s another way of determining the strength of the markets. There are a number of indicators that investors can use to analyze how healthy the markets are.
One obvious indicator is the strength of the markets themselves – in other words, how equities are performing. When equities are high, it’s a good sign that there’s something positive pushing values up. The higher stocks go, the greater confidence investors tend to have.
Of course high stock prices can mean that equities are being overvalued. Investors should take a look at the average P/E ratio of an index like the S&P 500 to figure out where average values are at. Right now the average P/E of the S&P 500 is 26.60 – far higher than the historical average of 15.64. That could mean that stocks are overvalued, but it doesn’t guarantee that a correction is imminent either.
The yield on the 10-year treasury is another tool investors can use to analyze markets. A low yield could mean that credit is easy, but that could be to encourage businesses to invest. Conversely, a rising yield can actually be a good thing, as it means that the economy is growing. In the past 6 months, the yield rose from 1.50 percent to 2.37 percent – a 58 percent increase.
Inflation is one of the most often looked at indicators for determining economic strength. Rising inflation, like yields, can indicate economic growth. Over the past 6 months, inflation has risen from a sluggish 0.8 percent to 2.5 percent – a whopping 212 percent gain. It’s a strong sign that the economic rally has a fundamental basis.
Finally, the PMI (Purchasing Mangers Index) can be helpful to investors by detailing how the manufacturing sector is performing. Generally a reading of 50 or less indicates an economic contraction. At 56 percent, the PMI seems to be telling investors that the U.S. economy is strong and growing.
Other than economic data, momentum can be a powerful influence on market direction. If positive momentum is strong and investor expectations are high, then markets can still move upward, even after the underlying fundamentals turn negative. Basing a market rally solely on performance can be misleading and leave your portfolio exposed to unnecessary risks.