Ron Bewley says it’s not unrealistic to look forward to another “smooth” bull market.
As we run to 5000 in the index – yet again – as I write this piece, it feels a bit like “Groundhog Day”. But have we learned anything, as did Bill Murray in the movie?
For years I have been following a statistic that I don’t usually write much about. I did some really heavy-duty research a while ago, working out what “cross-sectional” volatility (CSV) is and what it does! Put simply, one of the things I do is measure the co-movement or otherwise of stock returns in the top 200 on a given day. Each day I calculate the standard deviation of the 200 stock returns, weighted by market capitalisation.
In previous research I found that this little-used statistic drives the traditional measure of volatility. Put simply, when stock returns are moving together, CSV is low and there is no need to panic. When CSV is high, there is incentive to jump from one stock or sector to another, and that sets off mild or severe panic, and traditional volatility kicks up.
To make the chart clearer, I have taken the quarterly average of CSV and plotted it alongside quarterly data points on the S&P/ASX 200 in Chart 1. I use a log scale for the market so we can still see the 1987 crash in perspective. The black dotted lines merely indicate the lowest level of CSV and 1.5 per cent CSV, which seems to define a low or normal range of CSV.
The CSV around the GFC and the 1987 crash are the highest and, by chance, about the same level. The peak in the middle contains the 1997-98 Asian Crisis, the “tech wreck” and the 9/11 terrorist attack. The little peak above 1990-91 is at the time of our last recession!
The S&P/ASX 200 index had a great run from about 1991-2000 and again from 2003-2007. It seems that when CSV is low, we are on a bull run – but that doesn’t explain why we kept going in 1998-2000. Well, the Asian Crisis didn’t have much impact on us because we just switched whom we exported to, and we didn’t have a tech to wreck. But we did have a 1987 crash and a GFC!
If I now focus on the current data, CSV is about as low as it has ever been in recorded history. That bodes well – but the previous three or four quarters of CSV have also been low. Well, it took a year or two after the 1987 crash peak in CSV to get going again. Indeed, it wasn’t until CSV was well in the “dotted line” range that the market took off.
Another sign that gives me encouragement is the 12-month-ahead forecasts of the market and its sectors that I generate each quarter from broker forecasts of dividends and earnings. The average forecast returns strengthened by 3 per cent over the first quarter – I show the current forecasts in Chart 2. Energy has jumped out of the box with its expected return almost doubling to 40 per cent from the start of the year. Industrials also strengthened, but materials couldn’t keep pace with the upward revisions over the quarter – that sector’s forecast stays at around 20 per cent for capital gains.
The conditions are getting much better for Australia – CSV in particular – to break through the 5000 and play catch-up. Although I am not a fan of technical trading, if the market can gain enough “exit velocity” to break out of the doldrums and into numbers with a “5” handle, we might start to see another smooth bull run, like in 1990-2000 and 2003-2007.
Ron Bewley is executive director of Woodhall Investment Research – www.woodhall.com.au
