Three-Legged Stool

Bull markets are usually built on three legs. How far have we come?

The three legs of a bull market are valuation, growth, and retail purchases. They usually emerge in that order.

Valuation comes when everyone thinks the world is ending. We had that last winter. At it’s bottom, the market was selling at an “earnings yield” of 10%. That is, for every $100 you put into the market, you could expect $10 in earnings. That was when Treasury Notes yielded less than 3%. Now the market yields 5 1/2% while Treasuries yield about 4%. The value is there, it’s just less compelling.

Growth is the next leg. The economy has started to grow, so earnings will grow as well. Maybe not as fast as some expect or hope, but growth has unquestionably begun. The stock market anticipates the economy, usually by 6 months or so. Since economic growth has begun so can the stock market.

The final leg is retail participation. Up to this point, the stock market rally has been surprisingly devoid of mutual fund inflows. But that seems to have changed. During the week that ended on Christmas equity mutual funds received over 11 billion dollars, the highest weekly flow in a year and a half. While flows for the full year are down over $60 billion, it looks like this indicator is turning around.

With all three legs in place, it looks like the market can continue to grow. But don’t get complacent. When everyone is finally on board, the trip may be most of the way over.

Douglas R. Tengdin, CFA
Chief Investment Officer
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